The price of scarce resources
13 June 2017
All market participants desire a secure and well collateralised market, but there are real headwinds and issues that could increase market frictions. David Lewis of FIS explains
Image: Shutterstock
Beauty is said to be in the eye of the beholder, but in the world of securities finance and collateral, collateral acceptability is in the eye of the lender. Long gone are the days of the custodian-wide collateral schedule that all beneficial owners signed up to as a matter of course when they enrolled in a securities lending programme. Collateral requirements are increasingly bespoke and, particularly relevant in the data and benchmarking world, this had led to the adoption of the term ‘peer group of one’, symbolising how collateral specialisation can affect a programme.
Some of the regulations affecting the industry, and dominating every conversation and media article for that matter, also affect collateral requirements of lenders and are driving demand for certain asset classes and trade types for the borrowers. In addition, certain central banking policies can affect the supply of collateral in the market, both positively and negatively. In the maelstrom of forces affecting our industry at present, there are a number of related issues affecting how this part of the market is behaving. Concentrating on the G7 countries, as this is a typical refrain when beneficial owners seek a benchmark or standard definition of high-quality collateral, we can see changes occurring in the profile of this part of the market.
One of the significant causes of change in this area is the asset purchase programme being undertaken by the European Central Bank (ECB). In an effort to stimulate the European economy, the ECB has undertaken this policy of quantitative easing, purchasing government debt in order to put cash back into the economy. The relative success of this has been debated extensively elsewhere, but in terms of the securities finance market, it has had the effect of reducing the availability of desirable high-quality liquid assets (HQLA) available for borrowing. A limited securities lending programme, which makes a small amount of these bonds available back to the market, has had little effect.
Figure 1 shows the utilisation data (the proportion of assets available that have actually been borrowed) for the G7 countries over the last 15 months. Note Japan has been excluded for the purposes of this more Western economy focused analysis. The standout profile, and arguably with the most context given that the International Securities Lending Association’s 26th Annual Conference is in Berlin this year, is Germany, the largest economy in Europe in terms of GDP. A year ago, utilisation levels were around one third, or 33 percent of the available supply. In February and May 2017, these levels were just a fraction below 50 percent, indicating a growth of 50 percent in utilisation terms in just 12 months. However, the actual balances, in value terms, increased by just over 10 percent over the same period, indicating that the majority of the increase in utilisation is as a result of a reduction in the supply side.
Last December, the ECB announced an extension to the asset purchase programme (APP), lasting until the end of 2017, but at a reduced monthly buying rate of €60 billion from April. It also extended the definition of eligible assets, partly, some would argue, as it was running out of bonds to buy under the previous criteria. Other members of this sample have also seen increases—Canada has ranged between lows of 18 percent and highs of 37 percent, while France has seen a minor reduction overall. The UK has seen utilisation rates rise from around 20 percent a year ago to between 24 and 25 percent in the last quarter, but with a fall in absolute values being borrowed, again suggesting a measurable contraction on the supply side.
Only the US appears to diverge from the trend, with utilisation remaining relatively static across the last 15 months, as absolute volumes borrowed have risen. This effect is not too surprising given the increase in non-cash collateral usage in the US markets increasing demand, combined with the additional supply we see being unlocked by beneficial owners that may have previously not been open to lending these assets, particularly under term structures.
With increased demand, according to simple supply and demand economics, comes increased prices. In broad terms, the securities finance market is relatively price inelastic below certain levels of utilisation. In other words, below the point at which a security becomes hard to find, the borrowers retain the pricing power and rates remain low. Looking at aggregated borrowing fees paid for German government bonds over the last 15 months, we see an increase of 74 percent, reflecting, among other pricing variables such as the type of collateral delivered by the borrower, the decreasing supply of such bonds in the market. Despite seeing a net reduction in utilisation, borrowing fees for French government bonds have risen some 59 percent over the last 15 months.
One of the main drivers behind the increased demand is, of course, the need for HQLA for capital adequacy and liquidity purposes under Basel III, highlighting one of the conflicts between regulations and central bank policies. Increasing demands driving borrowing costs upwards, while raising welcome revenues for the beneficial owners of such assets, potentially increases the costs of those looking to comply with capital adequacy rules. The easing of collateral requirements by lenders in other areas of the market, including the potential for equity collateral usage in the US may ease some of these pressures, but there are also other areas which could restrict availability further.
The forthcoming Securities Financing Transactions Regulation (SFTR) reporting requirements, designed to bring transparency to the securities finance markets, may also deter certain lenders from continued participation in the market due to the need to disclose their trading activity.
While the potential impact of this is yet to be determined, it is another issue that will have to be considered when forecasting market activity/liquidity going forward. A delay to the implementation of this regulation is being talked about, but is not confirmed. Any relief on that front may well be short lived as other jurisdictions around the world implement the Financial Stability Board’s (FSB) transparency directive.
All market participants desire a secure and well collateralised market, but there are real headwinds and issues that could increase market frictions and, therefore, costs going forward, but a more coordinated approach between central bank policy and regulators could ease the transition while retaining a secure and orderly market.
Figure 1: Government bond utilisation rates over last 15 months
Source: FIS Astec Analytics
Some of the regulations affecting the industry, and dominating every conversation and media article for that matter, also affect collateral requirements of lenders and are driving demand for certain asset classes and trade types for the borrowers. In addition, certain central banking policies can affect the supply of collateral in the market, both positively and negatively. In the maelstrom of forces affecting our industry at present, there are a number of related issues affecting how this part of the market is behaving. Concentrating on the G7 countries, as this is a typical refrain when beneficial owners seek a benchmark or standard definition of high-quality collateral, we can see changes occurring in the profile of this part of the market.
One of the significant causes of change in this area is the asset purchase programme being undertaken by the European Central Bank (ECB). In an effort to stimulate the European economy, the ECB has undertaken this policy of quantitative easing, purchasing government debt in order to put cash back into the economy. The relative success of this has been debated extensively elsewhere, but in terms of the securities finance market, it has had the effect of reducing the availability of desirable high-quality liquid assets (HQLA) available for borrowing. A limited securities lending programme, which makes a small amount of these bonds available back to the market, has had little effect.
Figure 1 shows the utilisation data (the proportion of assets available that have actually been borrowed) for the G7 countries over the last 15 months. Note Japan has been excluded for the purposes of this more Western economy focused analysis. The standout profile, and arguably with the most context given that the International Securities Lending Association’s 26th Annual Conference is in Berlin this year, is Germany, the largest economy in Europe in terms of GDP. A year ago, utilisation levels were around one third, or 33 percent of the available supply. In February and May 2017, these levels were just a fraction below 50 percent, indicating a growth of 50 percent in utilisation terms in just 12 months. However, the actual balances, in value terms, increased by just over 10 percent over the same period, indicating that the majority of the increase in utilisation is as a result of a reduction in the supply side.
Last December, the ECB announced an extension to the asset purchase programme (APP), lasting until the end of 2017, but at a reduced monthly buying rate of €60 billion from April. It also extended the definition of eligible assets, partly, some would argue, as it was running out of bonds to buy under the previous criteria. Other members of this sample have also seen increases—Canada has ranged between lows of 18 percent and highs of 37 percent, while France has seen a minor reduction overall. The UK has seen utilisation rates rise from around 20 percent a year ago to between 24 and 25 percent in the last quarter, but with a fall in absolute values being borrowed, again suggesting a measurable contraction on the supply side.
Only the US appears to diverge from the trend, with utilisation remaining relatively static across the last 15 months, as absolute volumes borrowed have risen. This effect is not too surprising given the increase in non-cash collateral usage in the US markets increasing demand, combined with the additional supply we see being unlocked by beneficial owners that may have previously not been open to lending these assets, particularly under term structures.
With increased demand, according to simple supply and demand economics, comes increased prices. In broad terms, the securities finance market is relatively price inelastic below certain levels of utilisation. In other words, below the point at which a security becomes hard to find, the borrowers retain the pricing power and rates remain low. Looking at aggregated borrowing fees paid for German government bonds over the last 15 months, we see an increase of 74 percent, reflecting, among other pricing variables such as the type of collateral delivered by the borrower, the decreasing supply of such bonds in the market. Despite seeing a net reduction in utilisation, borrowing fees for French government bonds have risen some 59 percent over the last 15 months.
One of the main drivers behind the increased demand is, of course, the need for HQLA for capital adequacy and liquidity purposes under Basel III, highlighting one of the conflicts between regulations and central bank policies. Increasing demands driving borrowing costs upwards, while raising welcome revenues for the beneficial owners of such assets, potentially increases the costs of those looking to comply with capital adequacy rules. The easing of collateral requirements by lenders in other areas of the market, including the potential for equity collateral usage in the US may ease some of these pressures, but there are also other areas which could restrict availability further.
The forthcoming Securities Financing Transactions Regulation (SFTR) reporting requirements, designed to bring transparency to the securities finance markets, may also deter certain lenders from continued participation in the market due to the need to disclose their trading activity.
While the potential impact of this is yet to be determined, it is another issue that will have to be considered when forecasting market activity/liquidity going forward. A delay to the implementation of this regulation is being talked about, but is not confirmed. Any relief on that front may well be short lived as other jurisdictions around the world implement the Financial Stability Board’s (FSB) transparency directive.
All market participants desire a secure and well collateralised market, but there are real headwinds and issues that could increase market frictions and, therefore, costs going forward, but a more coordinated approach between central bank policy and regulators could ease the transition while retaining a secure and orderly market.
Figure 1: Government bond utilisation rates over last 15 months
Source: FIS Astec Analytics
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