(November 16, 2012) — Too often collateral is in the wrong place at the wrong time, according to a white paper by members of the European Union-based International Capital Market Association.
The authors of the paper foresee the demands of high quality collateral significantly outstripping supply in the future, and urge that it be treated as a scarce resource.
With demand and requirements up, the paper argues that IT infrastructure in the Eurozone is no longer up to the task of mobilizing assets and matching them with transactions.
“More attention urgently needs to be given to collateral fluidity, which in essence concerns the mobilisation of collateral, i.e. allowing it to be in the right place at the right time,” says the paper, which was produced by the Collateral Initiatives Coordination Forum, a subgroup of the larger trade association. “Achieving this requires that the plumbing be properly fixed, including through finally making progress with the continuing Giovannini barriers to EU cross-border clearing and settlement arrangements.”
Since the financial crisis, collateral has been an increasingly important tool to protect against counterparty risk.
“This is in no small measure related to the shift in risk appetite of market participants, with an increased demand amongst them to secure their credit risk exposures through the taking of high quality collateral,” the paper says. “Official policy makers have also significantly fuelled the demand for high quality collateral as they have advanced steps to make markets more robust, to reduce systemic risk and help mitigate the risks of any future financial crises.”
While this whitepaper is from an EU-based industry group and focuses on the status of collateral in that continent, many of the same forces are at work in American markets. The Dodd-Frank financial reform act significantly increased incentives for collateralizing over-the-counter derivative transactions. This includes instruments commonly used by institutional investors, such as interest-rate swaps. The more collateral parties put up in a transaction, the lower their regulatory burden to the Securities and Exchange Commission.