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Collateral scarcity may no longer be a talking point for the industry in 2023 and market participants could begin to see a return to pre-financial crisis markets, said Gareth Jones, CEO of Euroclear GlobalCollateral.
The remarks were made at the 5th Securities Finance Technology Symposium, where Jones indicated that the industry may “be at the point of inflection”.
The Symposium’s Collateral Management panel, hosted by SFT’s Bob Currie, examined how firms manage their cash, collateral and margins, and how this is key to maintaining a competitive advantage.
Panellists included Martin Walker, head of product management, Securities Finance and Collateral Management at Broadridge, and Jerome Petit, EMEA market specialist manager at Adenza.
Solutions architect at HQLAX Martin O’Connell and EMEA head of collateral services at J.P. Morgan Graham Gooden, completed the panel line-up.
Euroclear’s Jones noted that a reduction in settlement efficiency “by a couple of percentage points” was a key change toward the end of 2021, which had declined further during the Russian invasion of Ukraine. Although settlement efficiency has improved, it has not returned to where it was in the first half of 2021, he added.
“The reduction in settlement efficiency is typically associated with volatility and higher trading volumes, but it has been sustained for a while, which is an indication that there is some scarcity of collateral and securities liquidity out there,” Jones explained.
Despite the fact that settlement efficiency is still down, Euroclear’s specialist borrowing programmes — GCA for HQLA and Autoborrow — linked to the firm’s settlement algorithm, are facing high record volumes. This activity fits with the general trend being seen by market participants, the panel heard.
Jones said: “We all know central banks are holding very large volumes of assets as a result of asset purchases and we know that, with interest rates rising, it is almost inevitable that many people are positioned shorts. If you look to the US, they are ahead of us by six to 12 months in the interest rate cycle.
“About six months ago, the US market was starting to predict the balance between collateral scarcity and cash scarcity would start to reverse in Q3 and Q4 this year, as interest rates rose and the Federal Reserve began to unwind its asset purchases. The trends in the US are beginning to show that this change is now starting to take place.”
Adenza’s Petit noted that with the new market conditions, and with the application of UMR behind the industry, firms are now looking for more automation, more efficient optimisation of the inventory, as well as new solutions to manage this. He added that for Adenza as a vendor, “it creates opportunities.”
Continuing the discussion, Broadridge’s Walker indicated that the market conditions reinforced the need to “get the basics right” in terms of good quality data, timely processes and automation.
“[The industry has] seen with the LDI funds that firms are collateralising interest rate derivatives with bonds, with gilts, and firms are going to get risk on that. People need to get the basics right, supported by the vendors to deal with the market conditions, which are going to get a lot more exciting over the next couple of years,” Walker said.
As market participants recognised the importance of automation, HQLAX’s O’Connell noted that from the LDI experience, a number of firms had realised how constrained they were by manual processes.
O’Connell pinpointed that there was a “huge opportunity” here for vendors. He explained: “These opportunities do not come along very often, but when we see the pain points, which were highlighted by that liquidity crisis especially, it is apparent that scalability and automation need to be invested in to ensure that those firms have the capacity to cope with stress volumes.
“After a few years where firms have been concentrating on regulatory investment, the opportunity to re-focus on scalability and automation is now.”
