Across Asia Pacific, we are witnessing an inflection point as market participants are able to move beyond regulatory implementation to creating efficiencies and harnessing innovation to support future growth. With increasingly sophisticated collateral usage being driven by ongoing market and regulatory change, institutions are adapting to the new paradigms that affect their financing and collateral priorities. This includes the ability to leverage innovative structures intended to expand access into emerging markets and asset types.
At a roundtable hosted by J.P. Morgan, the discussion centered on four themes: inter-entity structures and integration, digitization and big data, pledge and the growing demand to finance Asian assets such as local government bonds. We will now explore these in more detail:
Globalization will continue to drive inter-entity structures and integrated trading
The focus on collateral globalization and decentralization has created a more balanced distribution of activity across regional desks. This is driving fundamental changes that include:
- Increased balance sheet allocation to Asian legal entities, with more cross-border trades and the addition of new market participants. Balance inflows have prompted operating model revisions in order to accommodate and better integrate with Asian requirements.
- Increased onshore financing from broker-dealers, who had traditionally utilized a single centralized global financing hub. Trades involving Asian assets are moving from Europe to Asian entities where they are executed with regional counterparts, utilizing cross-entity structures to take advantage of liquidity and reduced settlement cycles.
- A shift in trading behavior, even for trades that continue to be booked in a European entity. Increasingly, the management and execution of Asian assets are handled locally through Asian desks.
According to the roundtable participants whose firms have already consolidated fixed income and equities businesses, the creation of an integrated collateral trading desk has improved inventory management, interoperability and asset class liquidity. Consolidated desks can reap benefits that include more flexibility in meeting both existing collateral demands and new requirements stemming from non-cleared margin rules and cleared trades.
Broker dealers are seeking integrated collateral solutions to help achieve interoperability and optimization goals, particularly when working across regions or asset classes.
For institutions spanning multiple entities/jurisdictions, the ability to access a single platform that provides a unified view of global collateral deployment and utilization across the enterprise can be particularly beneficial in meeting interoperability and optimization goals.
- The ability to back-fill (or top up) trades with available assets supports full collateralization in accordance with collateral schedules.
- Onshore financing, in combination with a global, optimized tri-party collateral program, allows broker-dealers to efficiently mobilize their collateral across markets and asset classes.
- The ability to reuse collateral can support liquidity and collateral velocity across legal entities and with counterparties. Enhancements to allow further reuse will only increase the ability to move collateral along a chain; however, the growing use of pledge would restrict the ability to reuse collateral under those structures.
Digitization and big data will be critical to driving future optimization
Sources and uses of collateral are increasingly critical factors in front-office decisions, making the ability to optimize collateral based on specific institutional parameters and priorities an imperative. As firms look beyond simple collateral allocation and seek to make their collateral work harder, digitization and big data efforts are expected to play a significant role:
- The digitization of key operational and legal information will help facilitate a faster, smoother exchange of data inter-entity and with external counterparts, to speed program establishment and support collateral velocity.
- The adoption of digitized collateral schedules will create additional efficiencies by simplifying schedule updates and improving workflows between collateral providers, receivers, and agents. The introduction of self-service options will allow schedules to be reviewed and updated more efficiently.
- Big data and improved data analytics will facilitate more detailed reporting and become a guiding factor for future trading decisions. We expect to see automated, consolidated data fields from different trading venues; pre-trade analytics on consolidated asset pools to assess the best sources for collateral; optimized allocation algorithms to evaluate usage; and the introduction of streamlined and automated workflows – particularly in onshore markets such as Korea, Taiwan and Japan.
Pledge will be key to driving global capital efficiency
The market welcomed the release of standardized ISLA pledge documentation in March 2019 and an increasing number of pledge supported transactions are now being negotiated with counterparts. Roundtable participants believe that pledge will be more widely used on a global basis as lenders and borrowers become more familiar with the structure, benefits, legal documentation and commercial considerations. They observed that:
- Risk-weighted asset (RWA) benefits and related capital efficiencies are expected to increase the number of trades being supported through pledge structures.
- Pledge structures typically can attract higher spreads or increased haircuts; however, the RWA benefits for dealers mostly outweigh increased premiums.
- Collateral providers are discussing the right level of premiums to be paid and seeking transparency on market pricing to make informed decisions.
As an early adopter, the use of onshore pledge transactions in Asia is prevalent— particularly in the South Korea, Japan and Stock Connect markets.
Asia was an early adopter of the pledge structure, which has been used since 2012 as a way to address regulatory requirements limiting title transfer movements. Onshore pledge transactions are particularly popular in South Korea, Japan and China. J.P. Morgan currently supports pledge in Hong Kong, Japan, Singapore and South Korea, and China A shares via Stock Connect.
Desire for full asset utilization drives demand for Asian bonds
Roundtable participants noted that the days of letting an asset sit idly on a balance sheet have passed: if you are trading in a particular market, you need to be able to finance those transactions. In order to fully utilize their assets, broker-dealers are looking for broader access to Asian bonds—and we are starting to see some market changes in response to demand:
- With the third largest bond market in the world, the expected inclusion of China bonds in leading indices like FTSE and MSCI is anticipated to boost liquidity and build investor appetite to utilize them as collateral. Market participants want to understand how tri-party solutions can help to finance these assets, given current market infrastructure restrictions such local currency control, prohibition of securities borrowing/lending and ‘no trade transfer’ rules.
- As high quality assets, Japanese Government Bonds (JGBs) continue to dominate Asian fixed income collateral; however, inventory remains restricted given the substantial holdings that remain with onshore and regional banks. Tri-party solutions have been instrumental in easing access to onshore assets and mobilizing them for use by the global broker dealer community.
- Singapore, Thai and Korean Treasury Bonds (KTB) are increasingly in demand by dealers seeking to finance these assets and generate additional yield. For example, KTBs can be used to segregate Initial Margin, and can be also used as collateral under a pledge structure using the J.P. Morgan tri-party platform.
If you are trading in a particular market, you need to be able to finance those transactions. Using fixed income within a tri-party structure can help to meet those financing needs.
Overall, our participants were upbeat about the collateral outlook for Asia, pointing to balance sheet inflows, increased liquidity, additional buy-side entrants, and new structures and asset classes. Further efficiencies are expected as digitization efforts bear fruit, improving workflows and enhancing the ability to fully optimize global collateral usage. We would like to thank our roundtable participants for so generously sharing their experiences and observations.
Put our experience to work
As an experienced tri-party agent with a long history of providing collateral solutions in Asia Pacific, we see first-hand how markets are evolving and work closely with industry groups and market participants as they adapt. As our clients balance local and global collateral deployment, we deliver flexible solutions supported by significant investments in technology—helping providers and takers optimally manage collateral in changing markets.
For more information, please visit Securities Services or contact your
J.P. Morgan representative.