More than 80% of global asset managers are looking for backstops to dealer balance sheets as regulations have resulted in the sell side cutting back on liquidity provision according to a survey from BNY Mellon Markets.
Michelle Neal, chief executive of BNY Mellon Markets, said in a statement: “Many executives are seeking new relationships to backstop their existing liquidity providers, exploring trading with non-traditional counterparties and investigating participation on peer-to-peer liquidity platforms. There is a meaningful shift towards viewing the investment and trading process as much more than simply a series of transactions and this underscores why we’re reinventing our own business.”
BNY Mellon Markets, in association with PwC, surveyed senior buy-side executives from firms with a total of $12 trillion in assets under management in the first quarter of this year. More than 90% said demand for high-quality collateral and the frequency of margin calls increased during the quarter.
At the same time as the sellside has pulled back from liquidity provision due to increased capital requirements, the buyside has needed more collateral as more products have shifted to central clearing. In addition, new regulations have mandated the exchange of margin for uncleared derivatives.
James Slater, managing director and head of the collateral management and securities finance businesses at BNY Mellon, told Markets Media: "Since the implementation of the uncleared margin rules, we have not seen a shortfall in collateral but the buyside is increasingly concerned about its future ability to source eligible assets to meet margin requirements."
The first phase of the new regime mandating the exchange of margin for non-cleared derivatives came into effect for the largest market participants in September last year. More than 90% of survey participants noted a direct impact on their collateral obligations and almost all participants said both the demand for high-quality collateral and the frequency of margin calls have increased.
As a result, over 60% of buyside firms plan to move to an integrated model of collateral, funding and liquidity that can operate as an “internal capital market.”
Slater said: “The survey provides additional evidence that the buyside is taking action to mobilise collateral to meet the new margin requirements."
More than 80% are engaged in discussions to identify liquidity backstops to dealer balance sheets including trading bilaterally with non-banking institutions such as central counterparties that typically hold large cash buffers in their default funds (where this is allowed in local jurisdictions) and participation on repo and securities lending CCPs.
"Hedge funds are looking to consolidate existing relationships but other fund managers are looking to diversify their liquidity relationships in order to get balance sheet access,” added Slater.
Buyside firms are also considering participation on peer-to-peer platforms but said simpler client on-boarding and agreement negotiation processes are required. Respondents also indicated a need for receiving post-trade processing and settlement support that can be linked to the electronic platforms being currently evaluated.
Last year BNY Mellon acquired DBVX, a peer-to-peer electronic collateral trading platform, from Tradition, the Swiss interdealer broker.
"BNY Mellon invested in DBVX to empower all participants with the tools and infrastructure to provide financing and collateral to each other directly,"added Slater. "It aims to deepen liquidity by supplementing rather than supplanting counterparties.”
He continued that BNY Mellon is in the process of refining aspects of the functionality and working with the market to ensure DBVX goes live in the next couple of months with a pool of deep liquidity.
A recent report from the International Capital Market Association acknowledged the need for automating the highly manual and labour-intensive processes of the repo market in order to decrease settlement failures. The is important as the Central Securities Depository Regulation, expected to be implemented in the European Union in late 2019, will introduce penalties for settlement fails, when securities are not delivered, and a mechanism for executing mandatory buy-ins against failing transactions in financial securities.
Although some automation exists, credit repo desks still largely ‘cut and paste’ interests and axe lists which they share with their various counterparties from a combination of internal reports, Excel spreadsheets and a Bloomberg terminal. In addition, the credit repo market, unlike the sovereign bond repo market, is not centrally cleared.
“On the face of it, this is a market screaming out for automation, yet it is not that straightforward, particularly given the range of underlying bonds being borrowed and loaned, the different means of transacting, the range of counterparties, different haircut matrices, bespoke schedules for collateralising borrows, as well as the importance of counterparty relationships and the need to call an occasional favour (particularly when things go wrong, such as a buy-in),” said ICMA.