Regulation and Monetary Policy Present Challenges and Opportunities for Collateral Movement

Since the financial crisis, total pledged collateral has fallen and the velocity, or re-use, of collateral has also dropped, which has a negative effect on overall financial market lubrication. Going forward, monetary policy and regulation will further alter the collateral landscape providing both opportunities and challenges to increase the movement of collateral.

Speaking at the 30th annual RMA conference on securities lending, Manmohan Singh, a senior economist at the International Monetary Fund, presented how collateral has changed since the crisis. While pledged collateral from hedge funds, the largest provider of collateral, dropped from $1.7 trillion in 2007 to around $1.35 trillion in 2010 and 2001, this number has rebounded to $1.8 trillion at the end of 2012. However, collateral coming from pension funds, insurers, etc. via securities lending has dropped from $1.7 trillion in 2007 to $1 trillion in 2012.

Not only is there less overall pledged collateral, but there is also less re-use of collateral; collateral velocity measured in units has dropped from 3.0 in 2007 to 2.2 in 2012. Part of this drop has come as a result of a disconnect between regulations such as Basel III and central bank policy such quantitative easing, since the Basel committee may not have predicted QE continuing as long as it has.

To help solve the disconnect and introduce more collateral into the system, the Fed is working on a reverse repo program, but only banks are allowed to rehypothecate collateral received from reverse repo. So while more collateral will be available for pledging in areas such OTC transactions required by regulation, the structure of banks and nonbanks moving and re-using collateral will not receive a lift from this reverse repo.

One area of regulation that could help the velocity of collateral could be T2S, which will break down silos. The current structure of non-linked CSDs prevents the cross-border movement of collateral, but when T2S comes into effect, custodians will be able to access and move more collateral.

Part of the collateral shortage could also be solved by collateral transformation, but depending on final regulations, banks may not have the balance sheet space to do this activity. If regulations allow for transformation though, custodians, and even more so dealers, could increase collateral velocity, which would then bridge the gap between the supply and demand of collateral.