The critical role of innovation in helping institutions navigate the impact of ongoing regulatory change in the collateral management and securities finance space was the central focus of a recent BNY Mellon seminar in Frankfurt attended by leading buy-side and sell-side firms.
During the main panel discussion chaired by BNY Mellon Markets Group managing director Ingrid Garin, experts from Goldman Sachs International, Dekabank, Commerzbank AG, Société Générale and BNY Mellon considered how regulation is influencing trading patterns and product innovation in these areas, and drew a number of conclusions:
• There has been a fundamental shift away from repo into new trading structures, such as TRS, as a direct result of new regulations, not least Basel III and rules regarding stock loan trades.
• The combination of regulatory change and negative rates has seen tri-party agents and sell-side firms joining forces with the buy-side in order to drive both education and the implementation of new cash solutions, including new forms of collateral and innovative products such as structured notes.
• Tri-party agents are developing innovative solutions to ensure sell-side firms have access to high quality liquid assets (HQLAs)
• Regulation in the derivatives space is pushing corporates towards service partners who can develop ‘industrial’ collateral management solutions, not least the use of tri-party platforms to facilitate initial margin postings.
As Gesa Benda, Frankfurt-based managing director at BNY Mellon Markets Group, noted in an earlier presentation, regulations have enforced a number of limitations on existing trading patterns. “However, the securities finance market is innovative enough to accommodate new product solutions,” says Benda. “At BNY Mellon we are working closely with clients to support these new structures, for instance the use of structured notes, re-insurance trust (RIT) structures and special solutions for German KVG lending under AIFMD.”
With sell-side firms effectively being penalized for cash repo on their balance sheet, they are looking at alternative instruments which are less capital intensive, such as stock loan, TRS, structured notes, pledge structures. As Ingrid Garin notes, BNY Mellon is partnering with market players to ensure buy-side firms can continue to provide liquidity to the sell side. “Access to a supply of HQLAs is crucial for the sell side, but the regulatory environment has the potential to make sourcing those assets a more challenging proposition,” she says.
“As a result, sell-side firms are looking to tri-party agents to find innovative solutions – here in Germany, for instance, by providing support under the Alternative Investment Fund Managers Directive (AIFMD) for German KVG funds so they can maintain the volume of lending trades they undertake with German depotbanks via the tri-party mechanism. A reliance on bilateral lending would see access to the supply of HQLA assets dry up.”
Demand for HQLA is being driven by the enforcement under Basel III of a 100% liquidity coverage ratio (LCR), as James Slater, executive vice president and global head of securities finance at BNY Mellon, noted in a separate presentation. Coupled with limited opportunities for overnight repo due to dealer balance sheet constraints, this trend has resulted in an increased demand for transformation trades, and a rise in the use of securities lending as a liquidity tool.
“LCR makes the supply of short- term funding and lower quality assets less attractive,” said Slater. “Since HQLAs are lower-yielding, it offers limited return on capital, plus there is also a countercyclical impact: as demand for HQLA requirements increase, holders of HQLA will ‘hoard’ these assets.”