Asset owners are taking a broader view of collateral management, with more attention being paid by the front office to what historically was a back-office function.
Begun in response to the 2008-2009 financial crisis, the move to combine oversight of all collateral management — rather than segmented through securities lending and other services — has accelerated as Basel III recommendations and the Dodd-Frank Wall Street Consumer Protection Act have spelled out tougher trading and margin requirements for collateral. Those changes affect not only asset owners' securities lending programs but also their cash holdings, use of derivatives and overlays, and liquidity needed for private equity calls.
The rules — and the complexity of the investments to which they're applied — have meant what originally was simply matching credit with collateral has become far more intricate.
“The backroom work of securities lending, what used to be back office, is now of interest at the highest level,” said Virgilio “Bo” Abesamis III, executive vice president at Callan Associates Inc., San Francisco. “Now it's an investing thing.”
“The (pension fund) industry is going” toward executives taking a closer look at their collateral management, Gary McGuire, chief investment officer at Dow Chemical Co., Midland, Mich., which has $13.5 billion in U.S. defined benefit assets. “Because we trade a lot of derivatives, we monitor that collateral closely and daily.”
“It's now a matter of portfolio management,” said William Atwood, executive director of the $14.2 billion Illinois State Board of Investment, Chicago. “It's not about lending securities anymore, it's about borrowing collateral.”
If fully implemented, Basel III recommendations, pending European regulations and Dodd-Frank rules would require collateral to be much more liquid to meet two types of margin requirements: initial margin to cover the fluctuation in a contract's value over a fixed period; and variation margin to offset the daily fluctuations in the swaps contract's market value. Also, collateral will need to be posted through central clearinghouses rather than over the counter or through dark pools, and a variety of protections will need to be in place in case of counterparty default.
But with those rules comes the need for more oversight and more collateral. That, in turn, means more involvement and oversight from chief financial officers, chief operating officers, treasurers and pension fund risk managers, said Fergus Pery, director and head of Europe, Middle East and Africa open collateral at Citigroup Inc., London.
The broader view is “a blurring of the lines” between securities lending and collateral management, said Callan's Mr. Abesamis. “A pension fund client who is in both securities lending and in overlay strategies needs to know about its overall exposure to counterparties. The pension fund needs to aggregate its exposure and the type of collateral selected.”
The regulations “are punitive, in a sense,” Mr. Abesamis said. “Now, every counterparty has to make a determination that the collateral is the highest quality possible. That costs more, depending on the transaction.”