The view from Asia Pacific
No such thing as 'one size fits all' when it comes to collateral
When it comes to collateral, control is paramount—but how you define control depends upon your role. For example, borrowers want to be able to define optimal collateral allocation to address specific binding constraints, while lenders want access to more real-time reconciliation and automated processing of collateral schedules.
These were just some of the takeaways from a series of client roundtables hosted recently by J.P. Morgan in Hong Kong and Sydney, where collateral counterparts came together to discuss the local, regional and global factors influencing their financing and collateral decisions.
For broker dealers, these factors include the potential for more balance sheet decentralization, which could result in more financing being done directly by Asia Pacific entities. Lenders, meanwhile, saw the value of on-loan assets (and related collateral) rise during 2017, driven by underlying market strength.
Noting that significant work has been done to manage against capital requirements (with strategies that vary from firm to firm) and deploy assets more efficiently, there’s still more opportunity as markets continue to evolve.
Each institution is managing to its own unique mix of legal entities, regulatory oversight and binding constraints related to capital. Broker dealers continue to focus on optimizing balance sheet, and most are looking to define collateral allocation parameters and develop their own internal algorithms. Being able to make optimization recommendations to a collateral agent is a critical factor in adhering to capital requirements.
Borrowers and lenders also seek flexibility and agility in managing collateral schedules. For them, online tools support speed of execution and provide welcome transparency: Collateral providers can employ real-time queries to learn which counterparties can accept their collateral, while collateral receivers can monitor and adjust their eligibility criteria at a granular level based on their firm’s parameters.
For institutions operating in Asia, regulatory change has heightened the focus on being able to fund their activities locally and efficiently. In Taiwan and Korea, a successful framework has been developed that lets broker dealers mobilize once ‘trapped’ assets, using tri-party structures to deploy them onshore. Options such as total return swaps, e.g., the use of derivative trades for securities financing, could be used to derive additional balance sheet and capital benefits. Other markets such as the Philippines and Indonesia are exploring the use of tri-party structures to unlock liquidity.
New markets continue to spark interest, particularly China (with A Shares due to join the MSCI by mid-2018). Banks’ underlying clients, particularly hedge funds, are eager to hedge and want access to single stock swaps. Given the level of interest in China, borrowers agreed that having a China strategy now is essential, even though activity is likely to ramp up over a period of time given the structural challenges that will need to be addressed.
Innovative uses for tri-party, in particular pledge structures for collateral, were an active topic of discussion. Originally intended to manage haircuts or margin, pledge structures could be used for the entire loan exposure amount following the successful use of pledge models in tri-party for segregated initial margin. Pledge structures, which leverage the existing market infrastructure, could be quicker to market than other emerging options, such as CCP structures.
Broker dealers believe that pledge structures offer the potential for a reduction in the cost of capital, while lenders also see possible benefits that could include increases in spread, haircut and simplified reporting. However, one challenge for lenders will be explaining the impact of moving to a pledge structure and obtaining the consent of underlying beneficial owners. A standardized principal relationship agreement (GMSLA) and security agreement supporting pledge structures is expected soon from the International Securities Lending Association (ISLA).
Previously mentioned regulatory and funding requirements are also driving structural changes for broker dealers. Most have seen better integration across desks over the last few years, as financing is viewed more holistically than in the past. And, while many decisions related to capital allocation, financing or trading are still made centrally from New York or London, some of the firms represented at the roundtables are evaluating their booking models. Roundtable participants discussed a ‘hub and spokes’ model that could create greater regional autonomy, and noted that local support for increased collateral or financing activities would become ever more important. However, a ‘one size fits all’ model is unlikely, particularly given impending geopolitical changes such as Brexit.
Generally, participants seemed optimistic about 2018, although some broker dealers noted that the recent growth seen in collateral balances does not necessarily equate with balance sheet growth. In some cases, regional desks are benefitting from additional allocation of relatively flat balance sheets globally, due to higher yielding markets in Asia Pacific. Lenders feel that balance growth has been underpinned by market strength, but expect to see more borrows to hedge long positions in case of market turbulence.
We expect these themes to be important for some time to come, as the ongoing introduction of regulation in different markets is likely to have a continuing impact on how each firm manages their capital, financing and liquidity decisions. Given that, the need for control—with access to a variety of button and levers that can be pushed to create bespoke solutions—remains paramount.
J.P. Morgan held collateral roundtables in Hong Kong and Sydney between January 29 and February 5, 2018.
To learn more about our global collateral management offering, including our advanced eligibility management and optimization capabilities, please contact your J.P. Morgan relationship manager.
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