Liquidity through Collateral

Global Investor interviews John Templeton, managing director, BNY Mellon to discuss how clients are currently exploring collateral as a means to enhance liquidity in the current financial environment, and how the organisation addresses this challenge to benefit its clients. 

This article is part of the 2023 Collateral Guide, which can be accessed here.

Evolution in the global markets has created an opportunity for clients to align their securities finance and collateral management activities in order to meet their goals.

Collateral management has always been a critical component of the securities lending industry. In a securities lending transaction, the lender receives eligible collateral prior to or simultaneous to extending the loan. This collateral provides an important mitigant against the risk of counterparty default. And for many clients in securities lending, cash collateral provides an investment opportunity which can provide additional returns outside of the intrinsic value of the assets on loan.

It is incumbent upon the party receiving collateral to ensure that the guidelines of the collateral schedule accurately reflect the firm’s risk tolerances. It is similarly important to ensure that the operational process to receive the collateral is aligned with their perfection of security interest under the trading agreement. For many securities finance transactions, utilising a triparty collateral management provider is the preferred route to align operational efficiency and collateral eligibility analysis.

With the adoption of the uncleared margin rules, which requires the collateral be held at a third party, more firms have requirements to post collateral and have sought to meet those same goals of operational efficiency and alignment of collateral eligibility. This has led to a significant shift with many firms that have traditionally operated exclusively on the “receiving” side of triparty collateral management also becoming collateral providers on the platform.

Since the margin rules for derivatives prescribe what types of collateral may be delivered to meet collateral eligibility requirements, firms are looking for opportunities to better align their investment strategies with the margin rule needs. For example, if the provider of collateral does not naturally own assets that meet their margin needs, they can either alter their investment strategy (with the resulting impact to performance) or seek to engage in securities financing transactions to source eligible collateral to post.

This creates additional risks and opportunities for clients. First, many beneficial owners participate in securities lending through an agent lender. A critical part of optimising the collateral posted to secure transactions is ensuring that those assets do not have intrinsic value.

If the securities do have intrinsic value, the agent lender can lend them to generate those revenues and collateral without intrinsic value (i.e., GC) can be utilised to post as collateral. Many agent lenders offer opportunities to clients to “release” a portion of the cash collateral portfolio to utilise for general corporate purposes.

The economics of doing so for securities with intrinsic value typically compares favourably to raising overnight or ongoing financing. Alignment between the custody, agent lender, and triparty collateral management is crucial to ensuring that friction does not disrupt lending revenue.

Second, once the portfolio of available assets to post as collateral has been identified, clients can then compare their available assets to the collateral requirements to optimise which should be delivered to address each obligation. If the client is utilising a triparty collateral management provider, they can further optimise across obligation types – ie, derivatives and self-directed securities finance trades.

For clients who have the scale and priorities needed to invest into this process, the result of their work is an ideal end state with clients realising efficiencies in their posting of obligations across multiple agreement types.

They maintain securities lending revenues on their intrinsic assets, and other assets not needed for margin purposes. They also have the flexibility to reach financing counterparties, many of whom limit their bilateral financing activity for cost and risk discipline reasons.

At BNY Mellon, by integrating our solutions across collateral management and securities finance, we are helping our clients to meet their goals of realising revenues in their lending programmes while broadening their access to financing trades and counterparties.