The future of securities finance looks bright despite concerns about low demand and returns, according to Andrew Hauser, head of Sterling Markets Division, Bank of England, who also chairs the Securities Lending and Repo Committee.
Speaking at JP Morgan’s Collateral Management and Securities Financing Forum in London on March 27, Hauser was optimistic about the ability of the industry to survive. He dispelled four myths about the future of the industry, the first being that regulators and central banks wanted to destroy the repo and securities lending markets.
“Far from trying to kill the securities financing markets, central banks need them to thrive – but in a safer and more reliable way than they did pre-crisis.”
The second myth was that there would be a collateral crunch due to a rise in demand for high-quality collateral to meet new regulatory requirements. Hauser cited a 2013 study by the Bank for International Settlements that predicted demand for high-quality collateral would rise by $4trn as a result of liquidity regulation and margin requirements for clearing OTC derivatives.
“That figure, though huge in absolute terms, is much smaller than measures of global supply. The supply of AAA- and AA- rated government bonds, for example, has risen by over $11trn since 2007; the stock of non-cash collateral eligible for derivatives transactions is some $50trn; and the major central banks have transformed more than $4trn of collateral (some high quality, some less so) into the most liquid asset of all – central bank reserves – through their quantitative easing programmes.”
However, he said that if a global crunch is “far-fetched”, localised crunches in specific asset classes or markets may not be.
Limits around the flow of collateral have arguably caused greater concern, as suggested in a new report by Icma’s European Repo Council. Such barriers include collateral locked up in entities such as central counterparties (CCPs), funds that cannot or do not wish to lend securities, and operational rigidities posed by systems barriers or national borders.
Hauser said that while these are “real issues”, it is difficult to quantify their significance without “much better data” on the sources of demand and supply in the whole system.
He said it is a misconception that it is entirely up to public authorities to remove barriers to collateral fluidity. Public authorities such as central banks must “certainly must do what we can in areas within our control, both domestically and working in international partnership”. Indeed, the Bank of England has taken steps to extend the range of collateral eligible for its lending facilities.
However, Hauser said that most of the solutions to improving collateral fluidity will come from the market, particularly the best ones.
“Market solutions of course require investment, and investment requires an expectation of making a decent return. I recognise that such returns may be relatively few and far between in current market conditions. But I don’t believe that means the price mechanism will never work.
"As and when a more substantial imbalance between demand and supply of collateral does develop, as monetary policy normalises and financial market activity recovers, that will be reflected in a rising price of the relevant collateral. And that in turn will induce in greater collateral supply, and more investment and innovation in private sector solutions to collateral fluidity.”
The final myth that Hauser questioned was that there is no means to make an economic return on securities finance. He was optimistic that demand and returns would rise.
“… There are grounds for optimism about the medium-term prospects for securities financing. Demand will recover; and when it does, returns will rise. Those returns will in turn incentivise greater collateral supply and higher investment.
"But they will also incentivise innovation – and that I think is the most important message of all: the securities financing markets of the future will not look like the securities financing markets of the past, in terms of its players or its infrastructure. Change, perhaps quite radical change, is inevitable.”
Hauser concluded his speech by alluding to the Bank of England’s attitude towards securities finance: “… Central banks exist not just to bear down on risk, but also to foster safe, sustainable growth. And with that in mind, we have every interest in ensuring that there is indeed life after death for securities financing markets.”