At a conference in London Last November I dubbed 2010 as “The Year of Collateral”. From a business point of view everyone was placing more emphasis on risk reduction through more stringent collateral management procedures. Further, and more importantly, regulators were making it pretty clear that collateral is king. This year we have seen a lot of material on the subject.
When I got back from holiday recently, a journalist friend of mine, Paul Amery referred me to an article written by Gillian Tett of the FT. The focus of her article was on asset rehypothecation. Rehypothecation became a hot topic in the aftermath of the Lehman debacle. It became clear that assets were being used in some instances by their prime brokers to aid in the PBs’ own firm funding. I’m not aware of any suggestion of improper activity; it was more benign neglect on the part of the hedge funds not being aware of, or concerned with the use of the assets. In any case rehypothecation helped keep the funding costs down for the PBs’ so probably benefitted the clients indirectly.
The formidable Ms Tett, whose already successful career was catapulted into financial celebrity status through the financial crisis over the past few years, draws an analogy between collateral recycling and candy floss – spun sugar that fluffs up into something more substantial than it really is. She refers to a recent IMF Working Paper entitled “The (sizable) Role of Rehypothecation in
the Shadow Banking System” written by Manmohan Singh and James Aitken.
There are some major issues that they have right – the differences in leverage between the US and UK definitely drove the growth of the business in Europe. Of course, the results of the Lehman default have driven the business back to the US. I am not wholly in agreement with everything as outlined. For instance, both Ms Tett and the Working Paper authors suggest that dealers were trading collateral, often acting as if it were their own. Well, in the overwhelming majority of collateral funding trades, the collateral indeed was theirs to trade. And in the event that the purchased collateral gets rehypothecated, I am not certain that it’s a problem. No more so than any other asset that gets turned over. Take the fully paid for client assets out of the equation (and that’s the right thing to do) and you remove the “unreal” bit of the equation. There is also more than a bit of chicken and egg in the paper – is there less leverage because clients don’t want it, PBs won’t/can’t provide it or regulatory pressure is discouraging it?
I recommend that you read the article and the working paper. If you are in the securities finance business in any way collateral will become a bigger (and more expensive) part of your life going forward. There is a reason why Global Collateral Management is always one of our most popular courses at FinTuition. More and more firms are focusing on the activity and many are rethinking their approach to reflect the new paradigm.
I’m interested in your views - tell me what you think of the paper, or the wider issue of collateral.
P.S. Paul is editor of IndexUniverse.eu. Pauls' focus is ETFs and as we are all learning, the worlds of ETFs, securities lending and collateral all overlap pretty heavily. I recommend that you follow Paul's writing.
