Second in the Collateral Management and Regulation series co-written by The Field Effect and BNY Mellon, shining the spotlight on specific industry regulations and directives by distilling their aims and objectives.
We (The Field Effect and BNY Mellon) will consider the current and future collateral impacts and consequences – both direct and indirect, concentrating on market behavior. The importance of understanding the ‘consequences of change’ is a key theme which runs throughout this Paper. We believe it to be essential reading for corporate treasurers, asset managers, pension funds, insurance companies, banks and broker dealers, as it will explore whole market regulatory consequences.
As a result of the 2008 financial crisis and resulting suite of regulatory changes, the market has been driven to recognize the significance of collateral and its value in trading and risk mitigation. This realization has been the catalyst for collateral attracting an increased market focus, and becoming a standalone area of market expertise with some describing it as a new asset class. We believe market players may need to alter their mindset to function effectively and take advantage of the challenges and opportunities of the new collateral landscape.
To date, regulatory comment and research has been almost exclusively focussed on individual market segments. The term ‘regulatory’ in this Paper is used loosely in that it encompasses initiatives (including directives and reports) designed to influence market behavior and in turn impact the practices employed to manage collateral. The introduction of numerous interconnected, and at times possibly conflicting, regulations has resulted in some market players employing a ‘just-in-time’ or ‘self-preservationist’ approach. The benefits of a holistic collateral view represent a call to action for everyone. Even if you are not directly impacted by regulatory change, you may still experience an indirect business threat or opportunity as a result of the behavioral change of other market players. We believe that a firm-wide regulatory perspective is essential to complying with regulatory changes and delivering tangible benefits.
This Paper references statistics reported in the latest reports issued by the International Securities Lending Association (ISLA), International Capital Markets Association European Repo Council (ICMA ERC) and International Swaps and Derivatives Association (ISDA). This Paper focuses on the following initiatives as key influencers impacting and influencing the evolution and development of the collateral markets:
The Paper also examines the potential issues of implementing international regulations from a German perspective and highlight collateral developments in the Japanese Government Bond (JGB) market. We believe this Paper will provide valuable market insight from key BNY Mellon experts responsible for business areas significantly impacted by collateral regulatory changes.
The need to understand what’s happening in the wider market is not always on a firm’s radar. We believe the ability to be able to react in an innovative way in order to respond to regulatory threats and opportunities is a message which needs to be both widely disseminated and understood. We will see that doing nothing or employing a ‘wait and see’ approach is no longer a viable option; the new collateral landscape is taking shape now and demands your attention.
Since the 2008 financial crisis, policymakers have been busy formulating numerous domestic and international regulations, whose implementation is designed to minimize and contain the market-wide impact of a single participant’s failure. These changes are intended, inter alia, to improve the financial sector’s ability to absorb shocks arising from financial and economic stress and to reduce the risk of contagion from the financial sector to the real economy.
When catastrophic events occur, which are ultimately determined to have been a result of human error, natural reaction is to try everything humanly possible to ensure such errors are never repeated. The cause and effect chain is now in full swing; history may reveal whether or not these, or further enhanced regulations become a requirement.
It is our view that the implications of the new and constantly changing regulatory landscape present both opportunities and challenges which market participants have not yet fully assimilated into their philosophies. This potential failure to integrate market and legislative perspectives is compounded by delayed implementation deadlines and market uncertainty surrounding the collateral related regulations and directives.
The FSB plays a central role in promoting international financial stability. It does so by coordinating national financial authorities and international standard-setting bodies as they work toward developing regulatory, supervisory and other financial sector policies. It fosters a level playing field by encouraging coherent implementation of these policies across sectors and jurisdictions.
The FSB, working through its members, seeks to strengthen financial systems and increase the stability of international financial markets. The policies developed in the pursuit of this agenda are in turn implemented by jurisdictions and national authorities.
It is important to differentiate between a regulation and a directive in the EU.
Regulation vs. Directive in the EU
A regulation is a legal act of the European Union that becomes immediately enforceable as law in all Member States simultaneously. A regulation can be distinguished from a directive which, at least in principle, needs to be transposed into national law. However, it is up to the individual countries to decide how this will be achieved.
An ‘incomplete maze’ is one way of describing the new regulatory landscape. The aerial view, whilst complex, shows possible routes together with paths which are still under construction. Exit routes are not always obvious or in some cases, more than one is available. However, when viewed from ground level, the regulatory maze is almost impossible for each market player to navigate completely.
Each market player will experience its own unique set of regulatory impacts, as defined by its specific business profile and market segment. The mark of success lies in being able to identify and analyze what those consequences are and carefully considering how to respond to the opportunities or threats.
As part of the review process to identify regulatory impact we recently gathered key BNY Mellon experts and The Field Effect in a roundtable event. The objective of the roundtable event was to enable BNY Mellon representatives from the different market sectors to share and compare opinions on their respective collateral management developments. The event started by identifying and agreeing the main regulatory drivers impacting collateral. These were then discussed by BNY Mellon experts representing the impacted business areas.
A Collateral Grid (see below) was produced that referenced regulation and consequential collateral impact. The output from these discussions (in the form of direct quotes) and references to the Collateral Grid are made throughout this Paper. A regulatory impact score was attributed to each business area (2 points for direct impact, 1 point for indirect impact and zero for no impact) in order to generate a relative impact comparison across each of the business areas.
The key observations highlighted by the Collateral Grid are:
The aim of the new regulations is to influence market behavior, so it is unsurprising that changes in market behavior are being observed across many collateral related product areas. In order to identify and comment on the market changes, this Paper references data included in market reports regularly issued by market organizations such as ISDA, ISLA and the ICMA ERC report.
These detailed reports analyze market data and identify trends in their respective product areas, i.e. derivatives, securities lending and repo, providing a valuable source of statistical evidence to validate and illustrate our market observations. A recurring theme throughout the reports is the inter-connectivity between the respective market and the collateral impact of the various emerging regulations.
Ultimately, we believe the first key decision for any market participant is whether or not to engage a service provider partner and outsource or to perform the collateral function internally. In order to make this decision, a complete collateral impact analysis has to be undertaken. G-SIBs, such as BNY Mellon, provide the safety, security, service breadth and responsiveness that many clients are actively seeking.
We have covered a broad range of the regulatory landscape in this Paper, with the Collateral Impact Analysis Grid helping to summarize these regulations across market segments. Market players should consider this grid and compile an impact analysis checklist for their own business. Only then will you be able to answer key collateral questions which determine your collateral fitness, such as:
TFE is a boutique consultancy specializing in clearing and collateral management, spanning cleared and uncleared OTC Derivatives and Exchange Traded Derivatives.
We provide advisory services to every participant in the industry value chain including; buy-side and sell-side firms, clearing houses, custodians and CSDs.
TFE was founded and is led by David Field, an acknowledged expert in clearing and collateral management. With over 20 years of financial services consulting experience, David has led many clearing and collateral advisory projects across buy-side, sell-side, CCPs and custodians, spanning strategy, target operating model, and technology. David speaks at numerous industry conferences and is frequently quoted in financial services media.
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Senior Business Development Manager, EMEA
BNY Mellon Markets
EMEA Head of Business Development, Asset Managers & Sovereigns
BNY Mellon Markets
Managing Director, International Head of Pensions and Insurance Segments, BNY Mellon
Managing Director & Business Executive for Securities Finance in EMEA
BNY Mellon Markets
Senior Collateral Management Tri-Party Product Manager, BNY Mellon Markets