The Road to an Effective Collateral Management Program

The Road to an Effective Collateral Management Program 5 2 Source: Markit, PerformanceExplorer, 31 July 2018 • Collateral Upgrade Trades Collateral upgrades permit a firm to temporarily exchange assets of differing credit quality, allowing a firm to trade securities and raise high quality liquid assets to meet funding and liquidity requirements. • Cash Reinvestment Surplus cash can be reinvested to enhance returns and a variety of reinvestment vehicles exist that can be tailored to an investor’s unique risk profile and return requirements. Separately managed accounts, commingled funds, external investment vehicles, or lender self-invest models are common options. Firms will want to consider the size of the lending program, preferred levels of ownership, transparency, liquidity requirements, and influence on decision-making. • Securities Lending and Repurchase Agreements (Repos) Firms may consider maximizing portfolio returns and enhancing yields through securities lending and repos. Asset managers, pensions, and insurance companies can benefit from the increased return securities lending can bring, especially in a low yield market where margin compression encourages firms to evaluate all revenue opportunities. With lendable assets at an all-time high and fees and cash reinvestment rates recovering to pre-Global Financial Crisis levels, firms may find that they could be putting their idle assets to better use. 2 18.9% Securities Lending Market Size Dec ‘07 Dec ‘18 Dec ‘17 Dec ‘13 Dec ‘08 37.9 43.9 35.3 16.0 40.2 8.9% 8.7% 9.9% 15.8% $15.2 Utilization Rate Basis Point Fee $2.5 $21.1 $2.3 $19.3 $1.8 $14.8 $1.7 $9.3 $3.5 Lendable Assets ($B) On Loan Balances ($B)  4 Connect: Source Liquidity A critical aspect of a holistic collateral management program is liquidity management to ensure the availability of High Quality Liquid Assets (HQLA) to meet margin calls particularly in times of stress. Partially driven by local regulatory regimes, many firms have liquidity buffers dispersed across various geographies and divisions likely creating a sub- optimal use of these assets. Considering liquidity constraints and determining a hierarchy of uses for an asset can best be done when all of these pools of liquidity are brought into alignment and a risk based approach is taken to appropriately size buffers. To maintain liquidity access, firms should consider diversifying counterparties between different tiers or regional providers. Investment management firms can benefit from accessing additional balance sheet capacity through new dealer relationships or more structured arrangements with existing counterparties. In addition, to minimize the number of relationships they have to put in place and legal agreement burden, some companies may want to consider leveraging an agency lending program.