Over a third of financial institutions surveyed by Six Securities Services believe that it is acceptable for collateral to be low quality, complex and opaque as long as it is cheap.
The Vanson Bourne-conducted survey, which was carried out in December 2012, was based on telephone interviews with 60 industry participants across the UK, France and Germany (evenly split across the three regions).
The financial institutions interviewed were 55% buy-side institutions and 45% sell-side. Of the buy-side institutions interviewed, the average AuM was £56.7 billion.
In Europe, regulations mandating the central clearing of OTC derivatives come into force later this year, requiring financial institutions to post collateral to a CCP. Different margin requirements will apply to non-cleared collateral. Reports such as those from Accenture highlight a potential shortfall of quality collateral to meet the new regulatory framework.
The SIX Securities Services survey found that 43% believe that collateral should be simple, high quality, liquid and easy to value and 57% think that price of collateral is more important than quality
The research also finds that 53% of financial institutions estimate that high-grade collateral will increase in cost by about 9% before 2015.
In the race to find collateral, 48% of respondents agree that securitising and repackaging existing portfolios to create new collateral pools will result in additional risk and sow seeds for the next crisis.
Robert Almanas, managing director for international services, SIX Securities Services, said: “It is a frightening prospect that in today’s market, over a third of financial institutions are willing to accept collateral simply because it is cheap.
“When our competition begins to compete on the quality of collateral they are prepared to take, the ‘race to the bottom’ becomes a very real outcome.
“I am not convinced that we have enough quality collateral to keep the capital markets functioning, not just as efficiently as possible, but also in a safer manner than in the past. But repackaging lower quality, existing securities that are readily available is not the solution. Instead we must look to effectively mobilize collateral. To achieve this, the whole chain has to work, allowing the creation of a virtual pool across markets to eliminate the inefficiencies inherent in having to transfer securities across systems.”
Some industry participants have echoed Almanas’ comments and believe that rather than a shortage, there is a scarcity of collateral in that it will not be in the right place. “The challenge for the industry will be to get collateral to the right place,” said one industry source.
The publication of the survey results follows an announcement by the European Central Bank that it would include more asset-backed securities (ABS) in the scope of collateral it will accept. The move is intended to further strengthen its risk control framework. To maintain adequate risk protection, the ECB regularly adjusts its collateral eligibility rules and haircuts applied when accepting collateral in Eurosystem monetary policy operations.
The move to widen the scope of collateral to be accepted to include more ABS instruments has been expected given the requirement for OTC derivatives clearing as mandated by the European Markets Infrastructure Regulation (EMIR), the requirements of which must be adhered to by September 15, 2013.
“There are a lot of discussions in the market about the potential collateral crunch,” says Godfried De Vidts, chairman of the ICMA European Repo Council. “It is more about collateral scarcity in certain areas. In this area it is a good thing that we and central bank officials look at this from the point of view of why not prepare the market for a wider acceptance of different types of collateral before it boils over. Its better to prevent than cure – the central banks have this same type of forward-looking view.”
In addition, the ECB’s Governing Council has adjusted the eligibility criteria and haircuts applied by National Central Banks (NCBs) to pools of credit claims and certain types of the additional credit claims (ACC) eligible under the temporary Eurosystem collateral framework
Low Quality, Complex Collateral is Ok as Long As it is Cheap, Survey Finds
Over a third of financial institutions surveyed by Six Securities Services believe that it is acceptable for collateral to be low quality, complex and opaque as long as it is cheap.