Clearer route to returns
Euroclear, the Brussels-based international securities settlement system, sees the recent implementation of its real time system, as boosting its facilities for its different collateral management services.
Denis Peters of Euroclear, says that this is an area that is developing and is expected to grow much faster. “We see it as an opportunity for pension funds and other end users with cash balances to earn returns on these or even their securities balances at very low levels of risks.”
Of the four possible areas, the most active one is triparty repo, where lenders obtain extra returns on cash loaned to broker dealers and others.
The Morgan Guaranty Trust Company of New York, which operates the Euroclear sytem, normally provides the triparty neutral agent service. “In addition to performing the administration, they monitor the terms of the deals, do a mark to market on a daily basis and will issue margin calls, or they will even credit securities when there is an excess.”
The triparty service was first launched by Euroclear in 1994. “There has been a 400% growth rate in the past four years and compared with 1995, the average daily outstanding has grown from $7bn (E6.34bn) to almost $30bn.”
The triparty repo ‘flagship product’ has been extended to include triparty securities lending. “The two counterparties to a securities lending arrangement, hire a third party agent to ensure the agreement is fulfilled.” There is also a product the ‘triparty secured loan’ where the two sides agree to a longer term relationship: “This is where firms in need of securities on a longer term basis have a pool available to them,” says Peters. A more recent development is the ‘triparty derivative support’. “Here we use collateral to cover exposures deriving from derivative transactions.”
But even within the established tri- party repo the marketplace has moved on. “We have definitely seen a shift over the years, so that the cash provider is willing to take lower grade paper and more exotic types of securities. The majority of paper used in triparty repo is not the highest grade. The players willing to accept such terms are seen as the most attractive to do business with.”
Euroclear is convinced that the repo market will boom in the single currency environment with the disappearance of currency risk, says Peters. But it is not just that, as triparty deals are now becoming more part of the business. “We believe more and more professional investors will engage in financing for their securities transactions.”
The arrival of real time settlement (see IPE February page 30) at Euroclear means that transactions that were previously settled overnight for confirmation the next morning, can now be completed on a T+0 or same day basis. “This will be attractive to sophisticated securities professionals, as it will allow them to undertake more activity, with more securities that will become available to them. We will see more same day financing and an increasing appetite to borrow capital,” Peters predicts.
There has also been growing confidence on the part of ‘cash rich institutions’ in the repo markets. “They are becoming more and more comfortable in taking different types of collateral,” he adds.
Currently, the big cash providers are central banks, commercial and custodian banks, who may be doing it on their own account or for their underlying clients. “There are the occasional corporate and pension fund manager.” Such organisations have to have a direct account with Euroclear, he points out. Since it is a membership organisation, mainly for those involved in cross-border settlements, something that would not be available to corporates and pension funds, the decision was taken to relax the admission criteria and allow them to join Euroclear purely for collateral management.
Euroclear is the largest international settlement system in the world which had a turnover in 1998 of $44.9trn, equivalent to $177bn each day, he points out. “This is equal to settling the GNP of Belgium every two days.”
It also has a custody business, described as complementary to the core activities. This has assets in custody of $2.7trn. “We offer comprehensive but basic custody services, as many of our clients are local and global custodians. We do not want to compete with them, but to serve them as the custodians’ custodian.”
This, he points out, gives the end investor a choice of service provider. “When a pension fund gives gives a portfolio of securities to a custodian to manage on its behalf, the custodian usually makes the selection as to who the settlement agency might be for a cross border trade.” But there may be more risk control and it could be more cost effective to settle through Euroclear than through a network of local custodians.
He does not see this as cutting across the custodian, who would charge their normal margin, it would just be on a lower cost base.
Peters also believes that his organisation’s security lending programme, because of its position of virtually being “lender of last resort,” meaning that, “the fees being earned on those securities, which are usually lent overnight, are the highest in the marketplace.”
This, he thinks, could also be attractive to pension funds. Fennell Betson