Crossing the Collateral Rubicon

Crossing the Collateral Rubicon

A new territory of challenge and opportunity for sovereign institutions

April 2016
Hani Kablawi   |   Executive Vice President and CEO, EMEA Investment Services, BNY Mellon

In association with the Official Monetary and Financial Institutions Forum

Forewords

Hani Kablawi, BNY Mellon

New regulations, heightened risk sensitivity and rapidly evolving market dynamics are all making collateral management more critical than ever, as buy-side and sell-side firms alike find themselves confronted with new challenges and new complexities.

Collateral has always been integral to the extension of credit, but it is fast becoming the sole determinant of institutions’ ability to engage in financial transactions in the cash or derivative markets. READ MORE

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Executive Summary

Sovereign investment institutions around the world or Global Public Investors (GPIs) – broadly defined as sovereign wealth funds, central banks, public pension agencies and official development institutions – have since the 2008-09 financial crisis been gradually adjusting to their positions as systemically important players in the world economy.

These institutions have occupied the limelight for several years as significant providers of capital for international companies, governments and large-scale projects such as infrastructure.

Now, as the result of important regulatory and macroeconomic developments in the aftermath of the crisis, GPIs are emerging on financial markets in a new role as potential large-scale providers of high-value collateral to inject liquidity and facilitate many kinds of transactions of pivotal value to the real economy.

Providing collateral through sovereign institutions could play an important part in overcoming liquidity shortages which might otherwise drive up market volatility during periods of financial turbulence. Collateral trades thus could be one of the instruments helping prevent a recurrence of financial crises similar to developments in 2008-09.

Crucially, sovereign institutions are not subjected to the same post-crisis regulations such as Basel III and EMIR, which are impinging, sometimes with great severity, on their counterparties.

Without in any way undermining the letter or spirit of the new regulations, sovereign institutions can combine forces in the key field of collateral trades to make the financial system both more effective and less risky.

A key strategic undertaking for sovereign organisations is understanding the factors behind the new positioning, and how they can best profit from it, without deserting their fundamental financial conservativism and risk aversion.

Adapting to a new role as a central provider of liquidity to money and capital markets forms just one part of sovereign institutions’ tasks as they grapple with freshly evolving models of 21st century business and finance. For many public bodies, this amounts to crossing the rubicon into a new territory of challenge and opportunity.

OMFIF spoke with two dozen sovereign institutions in February and March 2015, totalling over $2tn in assets under management. Central banks, broadly speaking, show a smaller interest in securities lending than other GPIs such as sovereign wealth funds and public pension funds. However, some larger central banks are looking to undertake these trades in highly liquid developed markets to enhance income.

Sovereign institutions in a new environment

Regulatory and macroeconomic background

Navigating the collateral landscape

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