Liquidity and Collateral: Getting the Blood to Flow Again
Cash is a dirty word for some cultures, but not for financial services, on the contrary. But I am not talking about the old images of the stingy bankers holding on to their $ bills or about Scrooge McDuck.
Banks, custodians, CCPs, CSDs and exchanges are the financial institutions that enable the exchange of cash for securities, the movement of cash between bank accounts, the securitization of cash, the transformation of cash into collateral. Without these markets players entire economies cannot function: they are the safe and resilient pipes and the pipe operators that enable companies to be financed, investors to invest, prices to be made, etc.
The difference between Liquidity and Collateral is that Liquidity is the money used for overnight funding during the settlement, is the money that is in the treasury of a corporate or a bank to finance short term money needs, whereas collateral is usually a security that is given as a pledge to guarantee that one has enough money for a transaction, to bear the risk of a transaction, to be able to exchange it against cash if need be in a Repo transaction, at a CCP or a broker. Collateral was historically required to be of very high quality: high grade government bonds, sovereign or agencies. However these have become extremely rare as collateral is required for many more purposes now than ever to guarantee the stability and safety of every transaction. Banks have very little of it because keeping collateral on one’s balance sheet is extremely expensive from a regulatory stand-point. But if nobody oils the pipes, they cannot work anymore.
We have seen in our recent European Post-Trade Infrastructure Evolution: Switching Gears for the Long Run report that where collateral really needed to be optimized today was before settlement, and across assets and for listed and OTC assets. Until today this was not possible as assets were very rarely optimized between equities and fixed income, and that un-cleared derivatives, never making it to a CCP, where always excluded from cross-margining or netting opportunities offered, except after the settlement at the ICSDs but this is sometimes too late in the trade value chain.
This is changing though as Repo platforms and ICSDs have realized they needed to step in to enhance the fluidity of the financial blood. Today we are seeing a myriad of new initiatives that aim at creating some sort of “Collateral Exchange” whereby securities can be upgraded or transformed into more attractive collateral, or even exchanged against another one that is more useful at the time. Elixium with Tradition and Euroclear, Euronext’s Collateral Exchange, BoNY’s DBVX, 360T with Clearstream, the list is already long and is bound to get longer. We are excited to see how these new solutions will pan out and will be watching this space very closely. More in our two upcoming Celent reports about respectively collateral management and post trade technology.