04 April 2016
Reporter: Drew Nicol

Sovereign wealth funds cash in on collateral squeeze

Sovereign wealth funds and central banks are emerging as large scale collateral providers, according to a study by BNY Mellon and the Official Monetary and Financial Institutions Forum (OMFIF).

The study report, Crossing the Collateral Rubicon, covered 24 sovereign institutions with more than $2 trillion in assets under management.

Of the 24 participants, 37 percent said they are in advanced stages of considering collateral trades or already implementing them, while 66 percent reported that enquiries from potential counterparties to the trades were increasing.

Quantitative easing programmes have resulted in central banks acquiring significant amounts of government securities, moving them away from traditional suppliers of liquidity such as banks and brokerage companies, according to BNY Mellon and OMFIF.

These securities are among the most sought after for collateral trading. Governments that issue the highest-rated debt have had lower debt issuance in recent years, further constricting the supply, the report said.

"Collateral is becoming the sole determinant of institutions' ability to engage in financial transactions in the cash or derivatives markets," commented Hani Kablawi, CEO of BNY Mellon's asset servicing business for Europe, the Middle East and Africa.

"Since the financial crisis, new regulations have placed a premium on counterparties gaining access to high-quality collateral. Yet, central bank macroeconomic policies have reduced the supply of collateral. This has produced a great challenge for markets and a large-scale opportunity for official holders of these securities such as sovereign wealth funds."

Kablawi added: "We now have a situation in which the lower-rated securities that cannot be used for collateral trading are circulating more freely than the higher-rated securities, which have been taken out of the markets."

"While the mismatch between demand and supply for credit is evident in the US and the UK, it has become particularly acute in continental Europe and has been a major factor behind the sluggish recovery. Sovereign institutions that provide collateral are playing an important part in overcoming these liquidity shortages and limiting market volatility."

In turn, falling oil prices have helped to drive up demand for collateral from energy supplying nations.

One chief risk officer for a Middle East sovereign fund that took part in the study said: "In the current environment of low oil prices, the liquidity framework becomes more important so investment activity can continue.”

“We must make sure the liquidity profile is appropriate, prioritising liquidity over returns. In the future, maintaining the liquidity management framework is the key."

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