Collateralized Banking

Transcription

1 Collateralized Banking A Post-Crisis Reality Dr. Matthias Degen Senior Manager, KPMG AG ETH Risk Day 2014 Zurich, 12 September 2014

2 Definition Collateralized Banking Totality of aspects and processes relating to collateral as well as collateralized business, such as (OTC) derivatives trading, brokerage, Repo agreements or asset lending.* (*) Source: Collateralized Banking - Whitepaper, KPMG Germany (2014) 2

3 Overview 1) When Prime Brokers Fail 2) Response from Policymakers 3) Collateralized Banking Implications and Challenges 4) Summary Disclaimer: The opinions expressed here are purely those of the author, and may not be taken to represent the official views of KPMG. 3

4 When Prime Brokers Fail or: Lessons learned from the crisis Investment banks (and prime brokers) can and do fail Freezing of credit and money markets put spotlight on liquidity risk Assessment of risk was misguided and systemic risks were not transparent / understood Excessive leveraged financing and massive OTC derivatives market pose a danger to the stability of global financial markets and the real economy Absence of transparency on positions or activities in OTC markets 4

5 Response From Policymakers (1/3) Basel 3 framework Goal: Improve banking sector s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy Approach: Strengthening of global capital and liquidity rules Capital requirements Liquidity risk Leverage ratio Better quality capital, higher capital ratios, capital buffers Improved risk capture (mainly counterparty credit risk): Capitalization of CVA risks Stressed EPE Wrong-way risk CCP capitalization rules LCR (Liquidity Coverage Ratio): High quality liquid assets ( HQLA ) vs. expected cash outflows in a 30-day stress scenario NSFR (Net Stable Funding Ratio): Available vs. required amount of stable funding Principles for sound liquidity risk management and supervision Non-risk sensitive measure (Tier 1 capital vs total exposure) to limit the build up of leverage Calibration issue: backstop vs. binding constraint BCBS: 3% (draft rules) CH: 3.1%* US: 5-6% (*) 3.1% is called the Going-concern loss-absorbing leverage Ratio (TBTF) target and is calculated as 24% of the applicable 2019 going-concern loss absorbing capital ratio of 13% under the swiss TBTF regime (Source: SNB, Financial Stability Report 2014) 5

6 Response From Policymakers (2/3) OTC Derivatives Reform In Sep 2009, the G20 initiated a reform program to reduce systemic risk from OTC derivatives. The reform comprised four elements: All standardized OTC derivatives should be traded on exchanges or electronic platforms, where appropriate. All standardized OTC derivatives should be cleared through central counterparties (CCPs). OTC derivatives contracts should be reported to trade repositories. Non-centrally cleared derivatives contracts should be subject to higher capital requirements. EU (EMIR) USA (Dodd-Frank) CH (FinfraG) Rules focus on financial market infrastructure Mandatory clearing Risk mitigation / margin requirements Trade repositories Portfolio reconciliation Timeline: See Appendix Derivatives regulation rules within DF focus on Mandatory clearing Adequate financial resources for swap dealers Data collection, publication of swap repositories Finanzmarktinfrastruktur-Gesetz ( FinfraG ) closely mirrors EMIR Mandatory clearing Risk mitigation / margin requirements Trade repositories Portfolio reconciliation Timeline: See Appendix 6

7 Response From Policymakers (3/3) Margin requirements for non-centrally cleared derivatives In 2011, the G20 agreed to add margin requirements on non-centrally cleared derivatives to the reform program and tasked BCBS and IOSCO to develop consistent global standards for these margin requirements. Result: BCBS IOSCO consultative paper (bcbs261), September 2013 Timeline: Phased implementation, starts in Dec 2015 (however: No final rules text yet!) Margin requirements Margin protection and re-hypothecation Initial Margin ( IM ): Bilateral gross IM posting if outstanding gross notional of non cleared derivatives is above EUR 8bn threshold Variation Margin ( VM ): Must be exchanged (zero threshold) on a regular basis, low minimum transfer amounts Collateral eligibility: Limited to Cash, high quality government, corporate and covered bonds, equities of major stock indices and gold Margin protection: Implementation of specific arrangements (including third-party custody) that protect the margin One-time re-hypothecation of IM: Collateral collected as IM (cash and non-cash) can be re-used at most one time subject to a number of strict requirements. 7

8 Collateralized Banking Situation Today Banks reactions to these reforms: ETC BCBS IOSCO EMIR Basel 3 Further reactions range from One of the unintended consequences of the clearing initiative is that it may be transferring systemic risk away from the OTC world into the Repo market. to Central clearing essentially switches counterparty credit risk with liquidity risk A fair price for safety and transparency 8

9 Collateralized Banking Banks (1/2) Implications Challenges Collateral matters Increased demand for high quality collateral due to: Basel 3 EMIR Dodd F BCBS IOSCO Liquidity risk requirements (LCR) require banks to hold sufficient high quality liquid assets ( HQLA ) + Posting of margin (IM and VM) to CCPs when clearing derivatives; Mandatory risk mitigation (collateralization) for non-cleared trades + Bilateral gross IM requirements for non-cleared derivatives, One-time re-hypothecation of IM Supply / demand imbalance will likely increase funding costs for high quality collateral assets Target operating model for collateral management and optimization Re-visit current roles & responsibilities for collateral management (Treasury / FO / Risk / Ops) Back-office collateral administration vs. key front-office activity Definition & ownership of collateral optimization strategies such as Matched-book (Repo) trading; Internalization of collateral; and Re-hypothecation of collateral received Collateral planning activities (under normal and stress conditions), anticipation of collateral demand and supply Potential increase in (systemic) risk in stressed markets due to limited collateral fluidity 9

10 Collateralized Banking Banks (2/2) Implications Challenges Market and business model changes Derivatives markets: Future of bilateral OTC markets and evolution of cleared OTC business unclear Treasury / funding model: Move away from unsecured funding (punitive under Basel 3/LCR) Prime brokerage model: LCR and Leverage ratio requirements put pressure on traditional financing model for hedge funds Profitability Re-visit product offerings and re-structure (OTC) derivatives trading desks accordingly Re-visit service offering Prime Brokerage offerings Collateral transformation services Selection of and focus on right client base Operational complexity (B3, EMIR/FinfraG, BCBS-IOSCO) IT infrastructure enhancements Not the focus of this presentation Collateral is fundamentally changing the way how banks operate!!! 10

11 Collateralized Banking (Re)Insurers, Pension Funds, Corporates (1/2) Implications Challenges Increased (hedging) costs Provision of margins (IM and VM) for cleared and non-cleared OTC derivatives 2013 BNY Mellon Survey (see Appendix) Cost-efficiency #1 (collateral optimization) Increase quality of investment portfolio Conversion of assets from investment portfolio into eligible collateral Establishment of securities financing / Repo desk Amplification of margin calls amounts Amplification effects for long-dated trades: E.g. Liability-driven investment ( LDI ) hedging portfolios with long-dated IR swaps can trigger large VM calls due to high IR sensitivity Cost-efficiency #2 (ALM strategy) Re-visit current ALM hedging strategies, rebalancing of existing hedging strategies Limit use of swaps and exploit alternative forms of duration Additional amplification effects in stressed market conditions 11

12 Collateralized Banking (Re)Insurers, Pension Funds, Corporates (2/2) Implications Challenges Increased liquidity risk Holding of additional liquidity / cash to cover margin requirements Access repo market to fund VM calls for (cleared) swap portfolios Transformation of counterparty credit risk into liquidity risk; reliance on functioning of Repo markets Liquidity risk management: Planning of liquidity /funding needs for IM and (potentially large but expected) VM calls Stress testing and scenario analyses to assess effects of (large and unexpected) VM calls under stress scenarios and impact on liquidity reserves Operational complexity (EMIR, FinfraG) Achieve compliance with EMIR requirements 12

13 Collateralized Banking Hedge Funds Implications Challenges Changes to Prime Brokerage model Basel 3 impact Leverage Ratio: LR requirements* and balance / sheet pressure lead PBs to provide margin loans to hedge funds with less leverage Liquidity requirements: LCR, NSFR put pressure on the tradional financing services offered by PBs (maturity transformation**). Pricing / cost implications: Execution of highly levered strategies will become more expensive (e.g. Fixed income arbitrage strategies) Adapt to new PB financing model Achieve cost efficiency under the new PB funding model Re-visit trading strategies and adapt or abandon cost inefficient strategies Accept more risk? Shorter term financing, Early termination clauses; or less leveraged trades / more risky strategies (if you can no longer get the financing/leverage necessary to make an attractive return on less risky arbitrage strategies). (*) Securities Financing transactions ( SFTs ) are expensive under the Basel 3 Leverage Ratio as SFTs are considered gross (i.e. no recognition of collateral) and with only limited possibility for netting. (**) 30, 60 or 180d financing to hedge fund clients, funded in overnight repo market or by internalization through re-hypothecated client securities (e.g. use long securities of one client to cover shorts of another client). 13

14 Summary Post-crisis collateralized banking means collateral matters (!) Collateral fundamentally changes the way how financial institutions operate Collateral optimization a must for banks / an opportunity for (re-)insurers, pension funds brings a lot of challenges Unclear implication of changes in OTC market dynamics Adaption of business models / strategies to stay competitive / achieve cost efficiency Infrastructure enhancements / increased operational complexity but also opportunities Securities lending: Attractive opportunities for buy side (insurance companies, pension funds, corporates) to enhance yields by establishing / extending securities lending activities Brokerage service offerings: Top players will be able increase market share as smaller players are forced to reduce / close their brokerage business in order to save costs 14

15 Thank you! Dr. Matthias Degen Senior Manager Financial Services, Quantitative Finance Group KPMG AG Badenerstrasse 172 CH-8026 Zürich

16 Appendix EMIR / FinfraG timelines EU (EMIR) CH (FinfraG) Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 12 Feb / 11 Aug 2014 Reporting to Transaction Register July 2015* Clearing obligation Category 1 July 2016* Clearing obligation Category 2 January 2018* Clearing obligation Category 3 15 Sep 2013 Portfolio reconciliation Portfolio compression Dispute resolution (*) Expected development timeline 3 Sep 2014 Federal Council adopted dispatch on FinfraG Early Jan 2015* Clearing obligation regulatory technical standards ( RTS ) enter into force 4Q14 / 1Q15 Treatment in Swiss Parliament 1 Dec 2015* Variation margin applies and phase-in of initial margin: 1 Dec 2015: EUR 3tn 1 Dec 2016: EUR 2.25tn 1 Dec 2017: EUR 1.5tn 1 Dec 2018: EUR 0.75tn 1 Dec 2019: EUR 8bn 16

17 2013 BNY Mellon Survey Participants: 84 insurance companies; 75% had operations in Europe, 49% in the Americas 70% had life operations, 58% had non-life operations, 24% reinsurance business Gross premiums: 34% > $10bn, 46% < $2.5bn Assets: 37% > $100bn, 42% < $25bn Key results: 75% use derivatives to manage IR or FX risk 48% don t post initial margin today 61% pledge their investment portfolios as collateral 56% do not hold enough assets of required quality in their investment portfolios to support both cleared and OTC trades today Source: BNY Mellon, Collateral Management Survey 2013 Back 17

18 Appendix Literature BNY Mellon (2013), Collateral Management Survey 2013, Reserach paper ESMA, EBA, EIOPA (2014), Draft regulatory technical standards on risk-mitigation techniques for OTCderivative contracts not cleared by a CCP under Article 11(15) of Regulation (EU) No 648/2012, Consultation Paper, 14 April 2014 ESMA (2014), Clearing Obligation under EMIR (no. 1), Consultation Paper, 11 July 2014 Hartl et al. (2014), Collateralized Banking A collateral management approach for post-crisis banking, Whitepaper KPMG Germany Kirk et al. (2014), Matching Collateral Supply and Financing Demands in Dealer Banks, Economic Policy Review 20(2) Swiss National Bank (2014), Financial Stability Report