Liquidity management has changed dramatically over the last decade as a result of post-financial crisis regulations, and a new collateral management ecosystem is evolving, enabling traders to view inventory in real time and trade collateral peer-to-peer. Roberto Verrillo, Head of Strategy and Markets at Tradition’s multilateral trading facility Elixium, describes how firms today can optimise their liquidity management from a front-office perspective.
Growing demands for collateral have undoubtedly put a squeeze on firms’ balance sheets. In order to optimise liquidity management, the most important thing firms can do is centralise their margin requirements, repo desks, collateral requirements, and high-quality liquid assets (HQLA) needs in one place. Many of the more advanced banks have set up XVA desks to do just that, reducing liquidity fragmentation and providing opportunities for optimisation. Centrally funding the functions where collateral and cash are required clearly has benefits. Having bifurcated streams of demand all doing their own thing is a waste of resource and money.
Depending on where they sit in the ecosystem, many banks have struggled with balance sheet issues due to regulatory change since 2008. High-volume, low-margin businesses such as repo, have attracted big cuts in balance sheet from many of the major intermediaries. Although this year has been somewhat easier than last year, which was very challenging, the regulations that are still coming on-stream are going to create further problems down the line.
New rules will continue to squeeze balance sheets
The next phase of mandatory margining of OTC products is coming early next year, as well as the next round of Markets in Financial Instruments Directive (MiFID), and the Liquidity Coverage Ratio (LCR). The latter requires firms to report their balance sheets on an average basis rather than month-end, or quarter-end, which is where there have typically been squeezes in collateral demand and supply. There is also ongoing uncertainty around what form the Net Stable Funding Ratio (NSFR) is going to take. That was due to be coming in January, but will probably get pushed back because there is so much coming on-stream at the same time. New rules on money-market funds are expected from the European Commission; and the European Markets Infrastructure Regulation (EMIR) is looking at a one-year extension for OTC clearing for certain pension funds and not for others.
New rules and regulations will continue to come online in a relentless fashion. When all the current rules have gone into effect, they will be followed by the Fundamental Review of the Trading Book (FRTB) in 2021, which will be very onerous on banks’ balance sheets. It may require even more capital for them to continue to do ongoing business. The squeeze on intermediary balance sheets is not going to end anytime soon, and coupled to this, there is this regulatory drive towards efficiencies, best price execution, and transparency.
“For a business that is quite simple, like repo, there is no real reason why Client A shouldn’t face Client B or C. There are obviously hurdles to overcome, like credit and connectivity, but the new ecosystem will overcome those hurdles in time.”
A new ecosystem enables all-to-all collateral trading
Elixium came about because a lot of buy-side firms were increasingly disenfranchised by the way the current market works. There were reports last year of some of the majors cutting thousands of clients at a time, because they couldn’t cope with doing their business—it didn’t meet their return hurdles anymore.
For a business that is quite simple, like repo, there is no real reason why Client A can’t face Client B or C. There are obviously hurdles to overcome, like credit and connectivity, but the new ecosystem will overcome those hurdles in time. Those that are getting on with it are already trading in that environment.
Effectively an all-to-all electronic global market, Elixium is open in three jurisdictions currently and looking to expand out into Asia by early next year. Elixium has an MTF in the U.K., a European Operation in Paris, and a FINRA-approved ATS license in the States. We aim to be compliant with every current and future regulation.
Elixium is a collateral exchange enabling participants to trade baskets and single stock items, either via tri-party or bilaterally, and partners with global custodians and global agents that will be acting on behalf of their clients in some cases. In other cases, it has direct relationships with central banks, supranationals, banks, passive managers, pension funds, even down to municipals and county councils. Open to all, Elixium was created effectively to deal with the future requirements for collateral management from a front-office trading perspective. It partners with infrastructure and technology firms such as Global Collateral-DTCC, Euroclear and Lombard Risk as part of a wider collateral management ecosystem.
This new ecosystem will enable firms to move away from having small, fragmented pools of collateral, towards being able to bring all of their assets together in a cross-asset product, getting real-time settlement, and knowing exactly what their positions are, so they can optimise and decide with a firm-wide view what they can allocate, and what they can settle.
*Article based on comments shared during November webinar.