New York, London, Hong Kong, Singapore - A comprehensive academic study published at the London School of Economics and Political Science (LSE) and supported by The Depository Trust & Clearing Corporation (DTCC) has revealed that although an overall shortage of collateral is unlikely despite new global regulatory obligations and tighter risk controls mandating increased collateral requirements, access to collateral could become a challenge as firms seek wider sources of liquidity and assets.
The LSE study by Ronald Anderson and Karin Jõeveer, entitled "The Economics of Collateral", finds that the supply of collateral, in principle, will be sufficient to meet growing demands expected as a result of regulatory reform and evolving market practice worldwide. However, the study cautions that access to collateral and the ability for collateral to circulate freely across the financial system could become challenging as market participants seek sources of liquidity and assets worldwide. This limited access to collateral can be attributed to regional and product-focused market infrastructure, varying regulatory policies across markets, fragmentation at firm-levels and across local jurisdictions, and CCP product specialization.
The study advises that market participants and infrastructure providers must work together on technical solutions and processes that ensure streamlined access to collateral worldwide. Otherwise, the study continues, collateral demand, whether for clearing or regulatory capital requirements, could prove challenging to satisfy.
"For several years, there has been much debate on a collateral shortage. Our research has found that the challenge does not lie in the global supply of collateral in aggregate, but rather in the accessibility of collateral across markets and participants," stated Professor Anderson of LSE. "The search for new methods to alleviate bottlenecks and seamlessly allocate collateral is the next challenge for infrastructure providers and participants. Collaboration between participants and infrastructure providers will be crucial to ensuring an efficient process."
At the same time, the study predicts that if infrastructures remain fragmented firms active on several markets could experience an enormous increase in the number of margin calls as a result of moving trades to centralized clearing. For example, a bank clearing trades across four markets with a single integrated counterparty could experience a near 10-fold increase in margin movements if these were cleared through four separate CCP's. This, the LSE study suggests, could pose significant operational risks at a firm level as well as at a CCP level which could eventually lead to a system wide event.
Godfried de Vidts, Chairman of ICMA's European Repo Council, added, "We are at a cross-roads as an industry, where collateral is available to satisfy counterparty and regulator needs, yet credit-worthy borrower access could become threatened due to scalability issues related to an increase in margin calls and a lack of standardized global solutions across markets and firms. Now is the time that the industry must work together to ensure streamlined access to collateral worldwide."
Mark Jennis, Managing Director, Strategy and Business Development at DTCC, said, "In order to support the flow of liquidity and propel economic growth, we must ensure that we develop solutions that increase collateral velocity and provide operational scalability. We are actively working with market participants around the world and our peers to identify solutions that leverage global market infrastructure, while ensuring streamlined, efficient access and processing of collateral worldwide."
The findings of this study are based on an academic assessment of recent empirical literature on the supply and demand of collateral which focused on "collateral scarcity", as well as in-depth interviews with several industry experts. The LSE researchers' findings were based on a model of global collateral flows which was developed specifically for this study.
The complete LSE study, entitled "The Economics of Collateral", and a summary of study findings are available for download on the DTCC website.