SECURITIES LENDING & REPO MARKETS

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - OCTOBER 2010

CHALLENGES & OPPORTUNITIES

and time-consuming. It also requires having the appropriate collateral and risk manage- ment capabilities.

Furthermore, as the nature of collateral assets evolves and activity expands, marking to market becomes a crucial valuation challenge. This requires investment in both theoretical valuation algorithms and multiple internal and external sources of current and historical prices and volatilities to feed them. Prices have to be sourced from data providers such as Reuters, Bloomberg or Markit, but also from electronic trading platforms, investment banks and inter-dealer brokers. Players such as custodian banks or tri-party agents have integrated these aspects well and offer outsourcing services of collateral management to their clients, so that they can focus on their core business. Outsourcing collateral management to expert service providers is often more ef- ficient for asset managers and institutional investors from an operational and eco- nomic viewpoint. Additionally, collateral optimisation and management efficiency can be achieved by cen- tralising collateral and managing it from a pool of assets spanning various types of securi- ties, markets and transactions, such as repos, securities loans, OTC derivatives, cash and forex, as illustrated in figure 33. A trend also well integrated by major market participants.

Figure 33: Illustration of a typical arrangement to optimise collateral management

OTC DERIVATIVES

SECURITIES LENDING

REPO

FOREX

CASH

Pool of collateral COLLATERAL MANAGEMENT OPTIMISATION

Copyright CACEIS, 2010

The importance of high-quality and liquid collateral

3.4.3

Collateral is an essential component of securities lending and repo transactions and is the key factor which makes them attractive secured financing instruments, compared to other products.

However, what collateral one accepts and how it performs is of critical importance, espe- cially when things go wrong, as in the case of Lehman.

Securing transactions through collateralisation is necessary but, on its own, no longer sufficient. Cash investors have understood, sometimes the hard way, that collateral selection and the spread on financing transactions should take into consideration the liquidity factor of assets taken as collateral. The trend in the market today is towards high quality collateral that is liquid in the secondary market, so that in case of counterparty default, players are able to execute the collateral received in the markets.

3.4

Securities Lending & Repo markets | page 53