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Background to the establishment of the CICF

The following short article, which lays out the background to the establishment of the CICF, was published in ICMA’s first quarter 2012 quarterly report:

Collateral – an area of special focus for 2012 and beyond

The importance of collateral has grown over many years, but has accelerated significantly since the advent of the financial crisis in mid-2007.  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.  Official policy makers have also significantly fuelled the demand for 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.  Amongst examples of these increasing demands are:

  • increased focus on covered bond issuance by banks, secured against high-quality mortgage pools, as against senior unsecured issuance;
  • increased use of repo funding to finance assets, including in context of an increase in the use of central bank financing;
  • Basel requirements, to be translated in the EU through the CRR/D; introducing the holding of liquidity stress buffers – assets to satisfy these requirements comprise a short list of high-quality collateral;
  • the shift of standardised OTC derivatives to CCP clearing, as required in the EU by EMIR, which will give rise to demands for significant amounts of initial margin (as well as some increase in variation margin amounts); and
  • increased requirements to margin any bilateral OTC contracts (outside of CCP arrangements), incentivised by penal treatment of uncollateralised exposures in the CRR/D requirements.

Whilst these examples are couched in their European context, equivalent pressures also exist across global markets.

It is widely perceived that collateral demands will significantly outstrip supply, so it is essential that collateral be managed as a scarce resource.  Given the competing demands that exist for the use of collateral assets, the management of collateral needs to encompass the deployment of optimisation techniques – to ensure that the available collateral is utilised as effectively and efficiently as possible.

The industry is already exploring to what extent regulatory pressures may be mitigated through the acceptance of a broader range of collateral assets.  For instance, assets such as gold, equities and high-grade corporate debt may have a role to play alongside other already favoured collateral assets – cash, government bonds and covered bonds.  Similar debates are also pertinent in context of collateral for private contracts, where another alternative under discussion is the utilisation of credit claims (loans) as repo collateral, in lieu of the use of the hitherto favoured bond obligations (securities). Other potential efficiencies being pursued include:

  • harmonisation of requirements, for example so that central banks adopt uniform repo collateral pools; or so that each country accepts the same set of assets for liquidity buffer holdings rather than its own tailored set;
  • interoperability amongst market actors to avoid fragmentation of liquidity pools; and
  • usage of various forms of collateral swaps, so as better to match collateral sources to collateral uses.

However, each of these possible refinements comes with its own potential drawbacks, and public authorities understandably challenge the extent to which such refinements may be utilised.

The various public authorities are playing a significant part in influencing the changes to the environment for collateral.  A large part of this stems from their role in designing the new rules (EMIR, CRR/D, etc), but they are also responsible for certain directly relevant infrastructure projects, particularly including the ECB’s collateral central bank management (CCBM2) and TARGET 2 Securities (T2S).  As reviewed earlier in the infrastructure section of this Quarterly Report, at the 18 November meeting of the ECB’s COGESI, the agenda included a discussion on “Collateral issues”.  Effective industry engagement with these efforts will be essential to help ensure they prove truly fruitful and are coherent with the various associated initiatives which are already being invested in across the financial industry.

At this important juncture, ICMA considers there is a valuable opportunity to establish joint efforts to ensure that all collateral-related initiatives can be appropriately coordinated.  This should include identification of any synergies, including opportunities to leverage efforts and experience.  In the private sector ICMA is already seeking to achieve that by making available the necessary dedicated time from its staff to provide secretariat support to make possible a Collateral Initiatives Coordination Forum.  This will be chaired by Godfried De Vidts and engage a wide range of industry trade associations with interests in the broad topic of collateral.  An initial meeting of this Forum, which will inter alia aim to agree the Forum’s terms of reference, is planned for the end of January.  An important measure of the success of the Forum will be ensuring that its work can effectively be channelled into applicable official sector projects.

It should be recognised by everyone that a comprehensive and all-inclusive effort will be needed to optimise the use of collateral.