Euroclear Collateral Highway
HQLA investment
funds
An untapped collateral
asset class?
History in the making
The centre of gravity for the collateral
management industry continues to
draw its participants towards greater
transparency and new sources of liquidity.
The latest innovative development in the
world of refinancing made history on 10
November 2016 when two banks – Société
Générale CIB and Société Générale Prime
Services – exchanged a basket of HQLA
investment funds1 – issued by Lyxor Asset
Management – against cash, through
Euroclear’s triparty repo mechanism.
By outsourcing the post-trade management
of this repo transaction to a triparty agent,
both counterparties were able to benefit
from simplified processing on a basket
of securities, rather than on a line by line
basis, daily valuation of securities, related
margin calls and substitutions in real time.
Upstream, the transactions were carried out
via Elixium, Tradition group’s new electronic
trading platform, which is dedicated to
repo and collateral management.
The 'raison d’etre' of the new platform
is innovative as it anticipates a future
state where a European collateral stock
exchange will become a key component
of the financial markets.
The five stakeholders of Elixium have
developed the platform to facilitate
the different processing requirements
during the life-cycle of a repo while
simultaneously taking advantage of the
EUR1.15 trillion of outstanding investment
funds held in Euroclear France. Post-Brexit
and in line with the drive to promote the
French marketplace, this initiative is both
timely and appropriate.
This was a historic event as it was the first
triparty repo transaction carried out on an
electronic trading platform – previously
only processed over the counter. And, it
was linked to the first lending transaction
involving a HQLA investment fund in
triparty repo.
High Quality Liquid Asset: Highly liquid assets with top rating levels
1
Using HQLA funds as
collateral and why
it makes sense
New regulation and changing market
conditions have led to a shortfall in
the supply of traditional HQLA and an
increased need for banks to hold and
refinance new types of high quality
asset classes – such as HQLA funds. The
advantage of holding a HQLA fund is
that it allows the investor to invest in a
diversified yet secured bond environment
while entrusting his or her fund manager
to generate a positive return.
Recent history demonstrates other
tangible advantages. For example, since
early 2016, the EuroGovies Risk Balanced
fund issued by Lyxor Asset Management
has generated a return of +22bps,
i.e. +51 bps on Eonia. The same fund
showed a controlled level of volatility
– 50 to 60bps on a year-on-year basis
compared to a rate ten times higher for
the underlying bunds. And, HQLA funds
have the added bonus of complying with
Basel III requirements in relation to the
constitution of LCR (Liquid Coverage
Ratio) buffers.
But there are also other benefits.
First of all, outsourcing the collateral
management to a proven triparty agent
with the scale of Euroclear ensures
sound collateral allocation and valuation
procedures, while offering a wide range
of optimisation options. It is worth noting
that the monetisation process of a triparty
fund is identical to the monetisation
process of the directly held underlying
assets. Effectively holders can therefore
tap into a new source of liquidity without
any additional risk or complexity.
Secondly, the use of a trading platform
simplifies access to the collateral market
– and demystifies its complexity – while
offering more liquidity, transparency
and useful relevant information (such as
market data, legal contracts, credit items).
On top of these existing benefits, Elixium
intends to diversify its participant base
during the course of 2017 to meet the
requirements of banks and their buyside clients by gradually integrating asset
managers, insurance companies, clearing
house cash positions and non-financial
undertaking cash positions, which
represents a major competitive advantage
in a still fragmented world.
Why is this new process
attractive to the market?
The bigger picture
Triparty repo has evolved into a key way
of monetising assets1, allowing firms to
temporarily exchange securities against
cash (or other securities). In the case of a
fund, it replaces the need for the issuer of
the fund to redeem assets. This benefits
both parties as it prevents a capital loss
for the asset holder and protects the
stability of the fund for the issuer.
The monetisation of investments funds
via triparty repo is likely to become
increasingly important at European level,
particularly in stressed market conditions
where obtaining liquidity from traditional
HQLA can be challenging. But, the use of
HQLA funds as collateral in triparty repo
is just the first step. Eligibility of this asset
class with CCPs and eventually with the
ECB for refinancing is the ultimate goal.
Monetisation: the process of exchanging assets against cash, by way of sale, or through a reverse transaction
(bilateral repo or triparty repo)
1
The potential size of this new segment
means that the market is already looking
to the regulators to provide clarity. In
particular there is a need for a clear
definition of what exactly a HQLA fund is
and its underlying assets.
Additionally, standardised criteria will need
to be developed in order to determine
whether a fund meets the required levels
of liquidity in order to make it eligible as
collateral for triparty repo.
Irrespective of the initial teething
problems, any initiative that helps the
market broaden the assets with which it
can access previously untapped liquidity
pools is a welcome one. So it is likely that
the use of HQLA funds in the securities
financing business will continue to
increase as we move through 2017.
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