Repo market volumes skyrocketed during March/April as asset managers sought access to funding to provide cash for redemption requests and financial institutions more generally found themselves fielding increased margin calls from counterparties. A number of central counterparty clearing houses (CCPs) and bilateral counterparties, for instance, demanded increased cash collateral on OTC derivative positions due to the growing market volatility across nearly all instruments and assets.
This prompted a flurry of organizations to seek out high-grade collateral, such as sovereign bonds and other high-quality liquid assets (HQLAs). Moreover, it coincided with a period of unprecedented organizational adaptation across a number of financial institutions. As lockdowns were imposed, some financial institutions took a couple of days to acclimatize to their new working conditions, whereas the overall functioning of the market and its participants seemed always intact. However, the situation has since normalized. Furthermore, the intervention by central banks in repo markets has also helped stabilize markets, ensuring everyone had access to liquidity.
The importance of operational efficiency
Although liquidity was not adversely disrupted, the collateral management operations at some financial institutions were challenged during the Covid-19 crisis. Certain institutions, relied on highly manual processes within fragmented infrastructure, which meant it was harder for them to procure the necessary collateral in good time. Those organiziations who had not yet invested appropriately in their IT systems, had to learn about these lackings during the market stress. Timely delivery of securities across different collateral locations can be difficult under such cirumstances. However, those institutions who embraced automation had a clear edge and were able to navigate the crisis relatively seamlessly.
Automation is essential in ensuring that collateral can be obtained quickly and without excessive intermediation, thereby generating cost synergies, velocity and thus facilitate sound decision making. Additionally, it can also help firms obtain full visibility over their collateral and its nature. Conscious of some of the margining challenges that emerged during the Covid-19 crisis, increasing numbers of financial institutions are now seeking out smart tools that help them manage their collateral more effectively, even on an ISIN-by-ISIN basis. Technology will be key in helping firms manage their collateral processes and withstanding volatile events moving forward. Elsewhere, some firms will also be looking for collateral management solutions that are CSD-agnostic and fully interoperable.
Further automation and efficiency benefits in the collateral management space will eventually also be accelerated through the wider adoption of innovative technologies such as distributed ledger technology (DLT). As DLT increasingly matures, it could potentially be leveraged by market participants to provide them with a single source of truth providing unparalleled insights into where their collateral is located and its composition, whilst transaction costs would go down. The adoption of such new technologies is likely to be accentuated by recent events as firms look to optimize their collateral management operations.
Regulators bring transparency and efficiencies to the market
Policymakers will certainly use the recent crisis to drive through further reforms, a number of which will have a significant impact on collateral management and repo markets. For example, there is likely to be a renewed push around TARGET2-Securities, an ECB platform that lets users settle trades on a shared settlement platform with central bank money. By doing so, this could help market participants streamline the amount of cash liquidity they need to settle trades, potentially allowing to enter new counterparty relationships.
Although it has been briefly delayed by Covid-19, the Securities Financing Transaction Regulation (SFTR) is poised to bring further transparency to the repo market by requiring market participants to report details of their repo transactions to trade repositories. There are striking parallels between SFTR’s reporting provisions and the derivative reporting criteria outlined in the European Market Infrastructure Regulation. Regulators will acquire a better understanding of securities finance markets as a result of these disclosure rules, which can only be a positive development for the stability of the financial system as a whole.