Repo & SBL to the Rescue - Lombard Risk

Repo & SBL to the Rescue Written by Richard Gomm – Head of EMEA, Collateral Management Solutions

Once upon a time, in a regulatory landscape far, far away…

This may sound like an opening to a fairy tale, however the reality is that the regulatory landscape is now beyond recognition for even the most grizzled and battle hardened of collateral managers. Dodd-Frank, Basel III, EMIR and other global equivalents have provided a regulatory explosion which has the collateral pool shuddering at the concept of an unprecedented demand for collateral comprised of high-grade assets and an increase in haircut provisions. Whilst it is noted that increased collateral requirement in the market means greater safeguards against default, conversely the ever-increasing demand for high-grade collateral also has an inherent destabilizing market factor. Buy-side institutions have limited access to large inventories of high-grade collateral which gives rise to the phenomenon known as “Collateral Scarcity”.

Since the ’08 financial crisis, regulators have made huge strides towards stabilising the global financial system via regulatory reform.  This has essentially created a tornado of regulations, consuming all forms of high-grade collateral in the market, leaving a trail of fewer and fewer smaller institutions and buy-side firms in its wake as a direct result of the new and all-encompassing collateral requirements.  Additionally, liquidity ratios and capital requirements are coming under increasing pressure from regulators – all of which are fuelling the whirlwind ultimately creating a perfect storm.

To weather the storm, global financial institutions are striving to manage risks and collateral requirements as efficiently and as intelligently as possible.  Now more than ever, there is a distinct need to reduce the fragmentation of global collateral pools.  As a result, secured financing is now seen as one of the most effective techniques in meeting the new-found demand and squeeze on collateral pools.  Secured financing is an absolutely critical contributor to the efficient functioning of global capital markets.  The securities financing business is gathering momentum like a speeding train where Repo and SBL transactions have been established as the flagship securitised finance products, with more and more firms becoming savvy to their importance to the entire industry.  Repo and SBL are fast becoming the bedrock of capital market liquidity.

For those of us long enough in the tooth to remember the “good old days”, Repo and SBL transactions, in conjunction with collateral management in general, were somewhat viewed as a back-office function domiciled within operations – an afterthought in many ways.  However, these lowly transactions are now viewed as an integral component of the banking industry, aiding liquidity and effective inventory management.  Repo and SBL transactions are fundamental to the provision of an untapped global inventory of high-grade collateral to smaller institutions and buy-side clients, whilst simultaneously providing sell-side intuitions with further profitable business and revenue streams.  With this in mind, a significant by-product of regulatory reform is concentrated around the Repo and SBL market and the anticipation of an unprecedented spike in trading volumes.  However, gone is the era when efficient and effective credit risk management of Repo and SBL transactions could take place with the use of a notepad and an abacus.  The increasing market demand for these transactions brings with it additional complexity and operational challenges in supporting them, thus bringing FinTech companies and their solutions to the forefront of a previously somewhat antiquated collateral management space.

In conclusion, since the collapse of Lehman Bros, the use of Repo and SBL transactions has experienced a cultural revolution.  Long gone are the market perceptions that Repo and SBL collateral management is the poor cousin of its OTC counterpart.  No longer is Repo and SBL , or collateral management in general, lurking in the shadows of the more en-vogue front office machine.  Under the ever-changing regulatory landscape, post trade operations are becoming key drivers of profit.  Access to high-quality collateral positions via Repo and SBL transactions, coupled with competitive edge gained from technological efficiencies, are vital to market liquidity and thus the elimination or easing of the collateral scarcity phenomenon.  Are the historically undesirable Repo and SBL of the collateral and trading world now at the very forefront of market stabilisation?  From their humble beginnings, are these 90’s fashionistas known as Repo and SBL finally being given the opportunity to shine brightly and be seen as the platform for effective collateral and inventory management?  Whisper it quietly but…it has been said that it could now be a case of “Repo and SBL to the Rescue”.