Hani Kablawi | Executive Vice President and CEO, EMEA Investment Services, BNY Mellon
Brian Ruane | CEO of Broker-Dealer Services & Head of Banks, Broker-Dealer and Investment Advisors Market and Alternative Asset Manager Segments, BNY Mellon
This Official Monetary and Financial Institutions Forum (OMFIF) - BNY Mellon report focuses on the role that sovereign institutions may have to play in improving overall market liquidity, and contains results of OMFIF’s survey of 25 sovereigns with over $4.7 trillion Assets Under Management (AUM).
Hani Kablawi, Executive Vice President and CEO, EMEA Investment Services, BNY Mellon
Having entered a period of almost unparalleled change for the global financial community with political and economic uncertainty challenging investor confidence, it is perhaps counterintuitive to suggest that opportunities abound for members of the sovereign community. It would be more radical still to suggest that the benefits to the broader financial system that would accrue are central to the continued well-being of that system.
Historically, sovereigns have invested in High Quality Liquid Assets (HQLA) such as government bonds and main index equities as core holdings in their conservatively-managed portfolios. In the aftermath of the financial crises of the 1980s and 1990s, central banks in emerging markets began to accumulate substantial amounts of such assets, becoming one of the largest owners of HQLA, particularly G7 government bonds. As interest rates in economies of these issuers entered a steady downward trajectory, these assets proved to be good investments and critical to the defence of their currencies and economies, helping to avoid capital flight when the next crisis arrived in 2007.
Quantitative easing across major economies has, however, seen the likes of the Federal Reserve, European Central Bank, Bank of Japan and Swiss National Bank collectively leap-frog their emerging market peers as the largest holders of their own and other developed markets’ HQLA, including sovereign debt, equity indexes and blue chip corporate obligations. This hoarding of HQLA by central banks, eager to pump liquidity themselves, has had a significant ‘crowding-out’ effect, further straining primary and secondary market activity in these asset classes.
As demand has pushed down interest rates to ultra-low or even negative territory, sovereign investors have joined others in the hunt for yield, making higher allocations to riskier asset classes, carrying with them a heightened risk of illiquidity when monetary conditions or market sentiment inevitably change.
Broker dealers used to maintain large inventories of HQLA as the dominant intermediaries in fixed income and equities markets. However, recent major regulatory changes brought about principally by Basel III and Dodd-Frank have led these firms to cut back substantially on their trading books, transforming the market landscape, reducing liquidity and accessibility to HQLA. The impact of change on banks, and broker dealers in particular, such as tri-party repo reform, has brought stability but at the expense of liquidity and with increased costs for this traditional source of funding.
As the requirement to reduce the size of sell-side balance sheets has continued, opportunities have opened up to help bridge the mismatch between supply and demand of HQLA, as part of an integrated collateral management programme generating both liquidity in the marketplace, and incremental returns for asset owners.
The concerns raised by sovereigns surveyed for this report – counterparty risk, legal obstacles, regulatory barriers and limited secondary markets – will need to be addressed if they are to play an active role in easing these liquidity pressures. Their own internal governance rules may also need to evolve in order to realise the benefits of this new role at the centre of global financial markets.
Brian Ruane, CEO of Broker-Dealer Services & Head of Banks, Broker-Dealer and Investment Advisors Market and Alternative Asset Manager Segments, BNY Mellon
'Liquidity is the price you pay for stability’ – the impact of regulations on capital and liquidity have dominated the financial landscape since the financial crisis, creating an ongoing shift towards a more collateralised world.
Efforts to increase transparency and collateral mobility, as well as the safety and soundness of the global financial markets, have materially increased the demand for high quality liquid assets (HQLA)— outpacing the demand for all other asset types. Collective action taken since the crisis, including the regulatory imperative to clear and collateralise over-the-counter swaps, the requirement to hold such assets to meet liquidity standards, and the increased amount of cash in the system due to economic stimulus, are creating ongoing concerns around the continued availability of liquid collateral. In short, HQLA is now viewed as the financial system’s most important commodity.
Regulations stemming from Basel III, most notably the supplementary leverage ratio, the liquidity coverage ratio and the net stable funding ratio, are leading banks and broker dealers to continue to reduce their balance sheets, streamline operations, optimise posted collateral and allocate capital more selectively to individual business lines.
The requirement that banks hold higher and more liquid capital and rely less on short-term debt has raised funding costs. Regulation has also increased the cost of funding inventories through repo markets, thus market making has become less attractive to banks.
U.S. tri-party repo infrastructure reform has global implications due to the global importance of the U.S. Treasury market and Treasury holdings as risk-free assets. BNY Mellon explored this in greater depth in our recent paper ‘The Future of Wholesale Funding Markets.’
At this juncture, the narrative around wholesale funding and collateral management will likely move from the pure macro impact of regulatory reform to more specific implementation strategies and the emergence of market and regulatory reform.
A complex array of priorities facing the industry highlights the importance of having a comprehensive roadmap to help guide a firm’s collateral strategy and the new opportunity for sovereign institutions as natural long-term holders of HQLA. An increased focus on a global view of collateral management and the introduction of cleared repo products in the U.S. are expected to remain at the forefront of change, helping markets and clients alleviate pressures from risk, regulation and operational burdens. The ability to mobilise collateral across legal entities and countries is becoming increasingly important to the global financial system. Collateral mobility will improve the liquidity in the funding markets by making larger quantities of high quality assets more readily available to be moved across global liquidity pools.
BNY Mellon believes that our position as the U.S.’s largest tri-party repo agent and holder of collateral gives us a unique insight into the evolving market and provision of robust global collateral management solutions. We are delighted to partner with OMFIF on this important research paper on liquidity and look forward to engaging with you on the issues it raises in the period ahead.
For more insights from the key contributors, please watch our accompanying video or download the report.
BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may be used as a generic term to reference the corporation as a whole and/or its various subsidiaries generally. This material and any products and services may be issued or provided under various brand names in various countries by duly authorized and regulated subsidiaries, affiliates, and joint ventures of BNY Mellon, which may include any of the following. The Bank of New York Mellon, at 225 Liberty St, NY, NY USA, 10286, a banking corporation organized pursuant to the laws of the State of New York, and operating in England through its branch at One Canada Square, London E14 5AL, UK, registered in England and Wales with numbers FC005522 and BR000818. The Bank of New York Mellon is supervised and regulated by the New York State Department of Financial Services and the US Federal Reserve and authorized by the Prudential Regulation Authority. The Bank of New York Mellon, London Branch is subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. The Bank of New York Mellon operates in Europe through its subsidiary The Bank of New York Mellon SA/NV, a Belgian public limited liability company authorized and regulated as a significant credit institution by the European Central Bank (ECB), under the prudential supervision of the National Bank of Belgium (NBB) and under the supervision of the Belgian Financial Services and Markets Authority (FSMA) for conduct of business rules, and registered in the RPM Brussels (Company n° 0806.743.159), with registered office at Rue Montoyerstraat, 46, B-1000 Brussels, Belgium. The Bank of New York Mellon SA/NV operates in England through its branch at 160 Queen Victoria Street, London EC4V 4LA, UK, registered in England and Wales with numbers FC029379 and BR014361. The Bank of New York Mellon SA/NV (London Branch) is authorized by the ECB and subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority. Details about the extent of our regulation by the Financial Conduct Authority and Prudential Regulation Authority are available from us on request The Bank of New York Mellon SA/NV operating in Ireland through its branch at 4th Floor Hanover Building, Windmill Lane, Dublin 2, Ireland trading as The Bank of New York Mellon SA/NV, Dublin Branch, is authorised by the ECB and is registered with the Companies Registration Office in Ireland No. 907126 & with VAT No. IE 9578054E. If this material is distributed in or from the Dubai International Financial Centre (“DIFC”), it is communicated by The Bank of New York Mellon, DIFC Branch, which is regulated by the DFS and located at DIFC, The Exchange Building 5 North, Level 6, Room 601, P.O. Box 506723, Dubai, UAE, on behalf of The Bank of New York Mellon, a wholly-owned subsidiary of The Bank of New York Mellon Corporation. This material is intended for Professional Clients only and no other person should act upon it.
The Bank of New York Mellon, Singapore Branch, subject to regulation by the Monetary Authority of Singapore. The Bank of New York Mellon, Hong Kong Branch, subject to regulation by the Hong Kong Monetary Authority and the Securities & Futures Commission of Hong Kong. If this material is distributed in Japan, it is distributed by The Bank of New York Mellon Securities Company Japan Ltd, as intermediary for The Bank of New York Mellon. Not all products and services are offered in all countries.
This document is issued and distributed in conjunction with OMFIF Limited. Content is provided for informational purposes only and is not intended to provide authoritative financial, legal, regulatory or other professional advice.
Any statements and opinions expressed are as at the date of publication, are subject to change as economic and market conditions dictate, and do not necessarily represent the views of BNY Mellon or any of its affiliates. The information has been provided as a general market commentary only and does not constitute legal, tax, accounting, other professional counsel or investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. The information has been provided without taking into account the investment objective, financial situation or needs of any particular person. BNY Mellon and its affiliates are not responsible for any subsequent investment advice given based on the information supplied. This is not investment research or a research recommendation for regulatory purposes as it does not constitute substantive research or analysis. To the extent that these materials contain statements about future performance, such statements are forward looking and are subject to a number of risks and uncertainties. Information and opinions presented have been obtained or derived from sources which BNY Mellon believed to be reliable, but BNY Mellon makes no representation to its accuracy and completeness. BNY Mellon accepts no liability for loss arising from use of this material. If nothing is indicated to the contrary, all figures are unaudited. Any indication of past performance is not a guide to future performance. The value of investments can fall as well as rise, so investors may get back less than originally invested. Not for distribution to, or use by, any person or entity in any jurisdiction or country in which such distribution or use would be contrary to local law or regulation. This information may not be distributed or used for the purpose of offers or solicitations in any jurisdiction or in any circumstances in which such offers or solicitations are unlawful or not authorized, or where there would be, by virtue of such distribution, new or additional registration requirements. Persons into whose possession this information comes are required to inform themselves about and to observe any restrictions that apply to the distribution of this information in their jurisdiction. This information should not be published in hard copy, electronic form, via the web or in any other medium accessible to the public, unless authorized by BNY Mellon.
Trademarks and logos belong to their respective owners.
©2016 The Bank of New York Mellon Corporation. All rights reserved.