FROM THE DESK OF KELLY MATHIESON

Transcription

1 October 2007 FROM THE DESK OF KELLY MATHIESON Welcome to the latest edition of Collateral Management News. In this issue, we take a look at how collateral management has evolved beyond its origins in operational support to provide a range of sophisticated services and technologies essential to generating considerable value for both lenders and borrowers. We also feature an article from JPMorgan s Global Equity Finance Group which discusses the ever increasing scope of equity finance. As in previous editions of the newsletter, we bring you information on new people, upcoming information-sharing events and product developments that can all help to enhance the way you do business. One of our most recently developed products is JPMorgan CommanD SM. We are delighted to share with you the news that The Banker magazine recently announced the winners of its 2007 Technology Awards and JPMorgan CommanD topped the list for Custodial and Security Services Innovation. JPMorgan CommanD is the industry s first and foremost OTC derivatives collateral management service. We believe JPMorgan CommanD is a unique and innovative product and it s rewarding to have it recognized in the industry with this award. Aimed at financial institutions, asset management companies, corporates, government entities and hedge funds, it provides an end-to-end post-trade service incorporating valuations, Credit Support Annex (CSA) agreement management, rehypothecations, settlement and custody. JPMorgan CommanD enables our clients to take advantage of a more cost effective means of managing their collateral than many in-house alternatives and allows them to benefit from JPMorgan s extensive collateral management experience and investment in infrastructure. We are also pleased to announce that JPMorgan has recently added its 20th derivatives collateral management client. More than half of CommanD s existing client base includes large multi-national financial institutions, broker-dealers and asset managers including the World Bank, Resolution Asset Management, Standard Life Investments and JPMorgan Asset Management (UK), among others. Other existing clients include governments and pension funds, including the government of Canada and PFA Pension fund. The product has grown exponentially in the last two years as an increasing number of organisations see the value of a third party collateral management solution. It supports over 30 derivative instruments, balances of over $29 billion in derivatives collateral, and clients located in markets including Canada, Denmark, France, Ireland, Luxembourg, the UK and the US. JPMorgan CommanD was developed in close consultation with the market, and I would like to thank all those who have helped the bank achieve success in delivering this exceptional solution. We will continue to invest in the people, processes and technology supporting the product and look forward to developing our relationships with you. Your thoughts and suggestions on JPMorgan CommanD or any other topic are appreciated, and we encourage your feedback. KELLY MATHIESON Senior Vice President, WSS Collateral Management Business Executive JPMorgan Worldwide Securities Services kelly.mathieson@jpmorgan.com

2 INDUSTRY THE CHANGING ROLE OF THE THIRD-PARTY COLLATERAL MANAGER Collateralised financing has evolved from a capital markets financing tool into a trading instrument, balance sheet management technique and money market investment class that generates considerable value for both sides of the market. Likewise, third party collateral management has evolved to provide a range of sophisticated services and technologies essential to the realisation of that value. Collateral is the guarantor of the liquidity of the capital markets. It is what allows short positions to be covered and long positions to be financed. The use of collateral has now grown far beyond its origins in the repo markets, to become a trading tool and a balance sheet management technique that encompasses every asset class. It is the consequent administrative complexity that gave rise to the third party collateral manager. The role of the third party collateral manager is to provide sophisticated collateral allocation and optimisation tools across a broad range of geographies and instruments. At JPMorgan, major broker dealing clients now use third party collateral management to mobilise every instrument they trade across up to twenty seven separate markets. The most progressive use the service as operational support for a fully integrated internal collateral management and trading desk that spans every major business line: fixed income, equity and derivatives. By outsourcing all of these functions to a third party who can spread the costs over multiple clients, broker-dealers have found they can reduce their overheads, cut their technology investment costs and concentrate on trading and financing activities. Cash providers, on the other hand, find they can lend on a fully collateralised basis without any administrative cost. Third party collateral management on a global scale has enabled cash providers to enjoy enhanced yields without any loss of security or increase in administrative costs. But the value being released for both sides of the market by global collateral management is now being further enhanced by a range of new services. These include the development of sophisticated collateral allocation engines for collateral providers, including simulation functionalities and intra-day re-optimisation services, which are designed to help them finance their activities at the optimum combination of cost and flexibility. Maintaining the effectiveness of these collateral optimisation engines requires constant investment. Broker-dealing is a naturally dynamic business, in which both new asset classes and new ways of trading existing asset classes are broached continuously, and third party collateral management has to adapt constantly to maintain the balance between what broker-dealers hold and what cash providers are prepared to accept as collateral. The development in recent years of rehypothecation services, which facilitate the multiple re-use of collateral, is a good example of this. Rehypothecation, long used in bi-lateral markets, is an important product evolution for third party collateral managers, and will need to be available for complex international collateral and be fully automated to meet market requirements. JPMorgan has made collateral management a key strategic overlay to the clearing and settlement services it provides in over 60 markets around the world. The aim is to enable clients to mobilise collateral wherever it is held, in whatever form it is held, and for whatever purpose they choose, not only in domestic markets but across bordersaswell. It is an ambitious goal. As collateral has moved beyond cash and government bonds into corporate bonds, assetbacked securities, equities, and even mutual funds, bank loans and commodities, collateral managers have had to both work with independent pricing providers to address the need for pricing of emerging assets and broaden the range of cash providers they access. But the eventual vision of global collateral management is clear. It is to make available for use as collateral in any type of transaction anywhere in the world the entire inventory of a client, of whatever type it is and wherever it is held. There are many legal, regulatory, fiscal, cultural and corporate obstacles to the realisation of this grand vision. Even the lending of securities is not yet legal everywhere; the repo, securities lending and derivatives markets remain divided by obstacles as basic as multiple forms of documentation, and many investment banks have yet to integrate even their equity and fixed income divisions, let alone their derivatives and treasury arms. But it is the purpose of the global collateral manager to make these barriers as invisible as possible today, and eventually to help to clear them away altogether. OCTOBER 2007 EDITION 2

3 INDUSTRY EQUITY FINANCE MULTI-FACETED AND MULTI-DIMENSIONAL Traditionally synonymous with securities lending and with Prime Brokers financing of hedge funds, equity finance now ranges far wider than just these activities. In a guest article, JPMorgan s Equity Finance desk examines its evolution. Equity Finance is used by a wide variety of investors, including public sector, investment agencies, corporate entities, banks and private equity firms as well as hedge fund managers, to implement investment ideas on a leveraged basis. Equity finance desks still lend cash and securities on a collateralised basis in the way that they always have, but increasingly they are being judged by their ability to offer leveraged investment exposure through OTC derivative instruments and structured finance products such as credit default and total return swaps. This means that a successful equity finance desk is now a multi-faceted and multi-dimensional business, spanning all asset classes and every developed market. At its simplest, equity finance offers securities lending and financing activity. More and more frequently, it also includes synthetic financing via OTC derivative structures and derivative-based structured finance transactions. These are designed to enable investors to acquire leveraged synthetic exposure to particular investment sectors via index or sector swaps or notes or certificates that replicate the underlying asset class. The equity finance business also makes use of exchangetraded derivatives. Whether an equity finance client makes use of securities lending, OTC derivatives or structured finance depends on a range of factors, including tax and regulatory considerations as well as the objectives of the client and the appetite of the issuing bank for managing risk. The use of these techniques is not only confined to fund managers. They are also used by banks, inter-dealer brokers, broker-dealers, private equity firms and even corporate clients. For example, a hedge fund may use OTC derivatives to acquire exposure to a market or asset class on a leveraged basis, whilst private equity firms use them to make leveraged investments in companies, and corporate entities to raise money by issuing the equivalent of high-yield securities to hedge funds looking for investments with above-average rates of return. What all users of these instruments seek, and what all of these different techniques have in common, is the use of leverage. As a consequence of risk management, the banks which intermediate these transactions mitigate their credit risk exposure to the end-investor by requiring the placement of collateral. In a development of the collateral management process, securities lending desks may also play an important role in helping market counterparts manage their funding process by trading assets that are considered to be collateral. As an example, less creditworthy assets acquired for investment purposes can be difficult to finance directly, but are often used as collateral for loans of higher grade securities which can be used for funding purposes. These so-called collateral upgrade/downgrade trades are an important source of liquidity in the inter-bank market. The Global Equity Finance Group (GEFG) is part of JPMorgan s investment bank and provides its clients with market leading financial engineering expertise. The team is committed to the development and execution of innovative financing solutions to address the access and leverage needs of its demanding and diverse client base. To find out more, please contact: Europe, Middle East and Africa: Andrea Angelone andrea.angelone@jpmorgan.com U.S. and Latin America: John J McKenna john.j.mckenna@jpmorgan.com Asia Pacific: Neil Taylor neil.taylor@jpmorgan.com OCTOBER 2007 EDITION 3

4 INDUSTRY A TALE OF TWO SUMMERS It was the best of times, it was the worst of times For JPMorgan CommanD the summer of 2007 has proven to be successful. This is in contrast to the very volatile global market conditions stemming from concerns over the valuation, and over concentration, of market participants to the U.S. sub-prime fixed income market. For JPMorgan CommanD this summer has proven to be very positive, with continued strong market opportunities, industry recognition of the derivatives collateral management service, and the development of new product extensions and markets for the offering. This is in contrast to the very volatile global market conditions stemming from concerns over the valuation, and over concentration, of market participants to the U.S. sub-prime fixed income market. This challenging environment has tested the controls and scalability of JPMorgan CommanD, and the service has proven effective under increased risk cognisance and volumes. In July, JPMorgan CommanD was announced as the winner of The Banker magazine s Innovation in Custodial and Security Services award, recognising the first-tomarket innovation of the end-to-end service that pulls together disparate services - valuations, Credit Support Annex ( CSA ) margin management, securities and cash collateral management, cash reinvestment options, rehypothecation and dispute resolution - to provide a fully outsourced package and technologically seamless product for the client. Recognition of the valueadded components of the service has concurrently led to increased client demand for the product, with the onboarding of our 20th client in June, and an additional five clients mandating JPMorgan or ready to go live over the summer. The flexibility of the service in providing all aspects of derivatives collateral management has also prompted requests from clients in the Asia Pacific to extend product depth in areas ranging from wider margin management capabilities (bilateral repo, exchange traded derivatives, bond margin) to the ability to take on equities as collateral. Look out for further updates on these features as we continue to refine the service around the changing and evolving requirements of our clients. The market disruptions that began over the summer test the ability of the product to cope in a stress situation. To some extent they reinforce the need for a complete, controlled process run by experienced market practitioners on a stable and scalable technology infrastructure. The number of users collateralising using sub-prime assets under a CSA is small, as the market is currently dominated by cash and government or agency quality securities. However, we witnessed direct effects of the market turmoil in relation to the level of focus on data used in the collateral statements - especially versus perceived at risk names - and in relation to the volume of margin calls being made and received, the number of dispute reconciliations and the actual traded volumes under the CSA. In times of disruption it is also helpful to see potential impacts of different credit rating changes, the over/under concentration of certain assets in the portfolio and a view on the changes in the mark-to-market over a specified period. In a handful of instances, clients have been reclarifying the process adopted in the event of default under the terms of the credit support document. We hope that this period of uncertainty will come to a quick and positive end. We will continue to work with our clients to enhance our product offering so that they can concentrate on their core capabilities. OCTOBER 2007 EDITION 4

5 PRODUCT BUSINESS GROWS FOR U.S. EQUITY TRI-PARTY REPO JPMorgan continually invests in its suite of collateral management services to bring new features and functionality to its clients. A popular addition is our U.S. equity tri-party repo product. FUNCTIONALITY FOR FLOATING RATE REPOS Earlier this year, JPMorgan moved almost $11 billion of a key client s U.S. equity repo activity to its Clearance and Collateral Management System (CCMS). JPMorgan s CCMS platform supports the U.S. Equity Tri- Party Repo (TPR) product introduced in late 2006, which continues to gain huge momentum in The TPR product is the culmination of 18 months of work that included market analysis, extensive product and technology development, training and sales activity. The service went live with a major broker dealer client moving $2.5 billion of collateral across two counterparties. Today that client has expanded its business significantly, and across six counterparties. JPMorgan has recently given particular focus to increasing the strength of its collateral management team globally. In September, Mark Hartzell took on the role of global head of Clearance and Collateral Management Sales. Mark has been with JPMorgan for five years, and was previously head of Treasury and Securities Services Sales Strategy. Prior to that Mark was head of JPMorgan s Global Trust Company Sales Organisation. Mark is New York based but will spend a large part of his time in other regions worldwide in support of JPMorgan s global collateral management business. In May, Karl Wyborn was appointed Asia Pacific Regional Head for Clearance, Collateral Management and Escrow. Karl, previously global head of Derivatives Collateral Management Sales, immediately relocated from London to Hong Kong. His initial focus has been one of identifying specific opportunities and success drivers for collateral management by location. In the first nine months since product launch, total balances across all clients exceeded $40 billion. This complements the JPMorgan s international business which exceeds $350 billion. The new platform provides greater opportunity for growth, which benefits both JPMorgan and its clients. Clients using TPR are continuing to build balances and increase lenders after their initial implementation, with up to as many as 40 counterparties. WSS Collateral Management Business Executive Kelly Mathieson is thrilled with the success of the new TPR product and notes, It is always exciting to bring a new product to market and see clients reaping the benefits. Clients are pleased with this new technology and the added returns they receive. EXPANDING THE TEAM GLOBALLY Meanwhile, Benoit Dethier has relocated from London to Madrid to support JPMorgan s collateral management and overall securities services business in Spain and neighbouring countries. Benoit is working with clients, prospects and industry bodies in the region to further promote the use of securities lending and collateral management. In July, Katie Emerson joined the Derivatives Collateral Management Sales team from JPMorgan s Investment Operations Outsourcing unit. With demand for JPMorgan CommanD as strong as ever, Katie is responsible for working with the fund managers, banks, corporates and other organisations currently interested in the product to scope out and tailor a solution to their needs. Katie is based in London and working with organisations across Europe. Finally, in October, Colm Gaughran joined as Global Product Head for Derivatives Collateral Management. Work is currently underway at JPMorgan to handle floating rate repo transactions with a benchmark rate plus or minus a spread. This new functionality will allow for clients to instruct on deal initiation. All daily changes due to benchmark rates changes will be automatically processed by JPMorgan, thus eliminating the need to send in daily updates. The current release date is the first quarter of PEOPLE Colm joins from Fidelity where he was responsible for the strategic development of infrastructure to support derivatives strategies. Colm was a key member of Fidelity's Derivatives Strategy Group, and has over seven years' experience in OTC derivatives, Collateral Management and Risk and Performance analysis. OCTOBER 2007 EDITION 5

6 EVENTS JPMORGAN DERIVATIVES COLLATERAL MANAGEMENT FORUM IN LONDON No alternative asset market has grown more quickly than OTC derivatives contracts, and JPMorgan remains at the forefront in supporting clients in this area. The latest in our series of derivatives forums will provide an update on developments and opportunities for operational success. On 31 October JPMorgan will host a forum in London on Success in Derivatives Collateral Management. The event will provide an update on the latest developments and opportunities for operational success in derivatives collateral management. It will cover a variety of topics including trends in OTC derivatives, managing an OTC derivatives collateral process and overcoming the cost associated with using cash collateral. It will also look at considerations for fund managers and others in OTC derivatives usage and explore areas including valuation, UCITS III, liability driven investments, re-hypothecation and managing and monitoring credit events. Some of the market s leading participants, including a number of our key clients, will cover the event will be held at JPMorgan s Victoria Embankment office in London. For more information, please contact your usual JPMorgan representative. JPMORGAN COLLATERAL MANAGEMENT CONFERENCE IN PARIS Following the success of our conference in Frankfurt earlier this year which brought together 150 market participants to discuss trends in the industry, JPMorgan will host a similar event in Paris in January. JPMorgan is pleased to announce that it is hosting a Collateral Management conference and dinner in Paris in January The event will provide a great chance to network with peers and learn more about the latest developments and opportunities in collateral management for repo, securities lending and OTC derivatives transactions. Some of the market s leading participants, including a number of our key clients, will cover topics including the evolution of tri-party services, the triparty model versus bilateral, achieving success in OTC derivatives collateral management, and regulatory issues in collateral management. We very much hope you will join us in Paris. For more information on any of the articles in this newsletter, please contact: U.S. Mark Hartzell mark.d.hartzell@jpmorgan.com EUROPE, MIDDLE EAST AND AFRICA Kirit Bhatia kirit.bhatia@jpmorgan.com ASIA PACIFIC Karl Wyborn karl.wyborn@jpmorgan.com Issued and approved for distribution in the United Kingdom and the European Economic Area by J.P. Morgan Europe Limited. In the United Kingdom, JPMorgan Chase Bank, N.A., London branch and J.P. Morgan Europe Limited are authorized and regulated by the Financial Services Authority JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A OCTOBER 2007 EDITION 6