The evolution of Triparty Collateral management
Four years ago, BNP Paribas Securities Services became a triparty agent in order to answer the demand for this type of solution and anticipating opportunities it would unlock in the future.
Fast forward to 2021, and triparty collateral management has confirmed its value to market participants in terms of operational efficiency and reduction of risk.
With the buy-side getting to grips with triparty, new eligible forms of collateral, and the advent of new technologies, the future is bright for triparty.
The buy-side demand for Triparty services
Participants in repos and securities lending enjoy operational savings, reduced risk and greater trading opportunities. Given these benefits, buy-side firms are being encouraged by sell-side firms to adopt triparty. In this way, they achieve greater connectivity between market participants, with more standardised operating models. This in turn allows the sell-side to benefit from greater collateral optimisation.
There is a perception that becoming a triparty participant is a complex endeavour. While new clients of a triparty custodian need to go through a full onboarding process, firms already set up with an asset servicer can join up very quickly. For these clients, triparty is just another service alongside fund administration, depositary banking services and agency lending.
Initial Margin further motivating the adoption of Triparty Collateral management
While the market was beginning to prepare for the first wave of the uncleared margin rules (UMR) in 2015 and 2016, discussions were underway as to how the buy-side would approach these regulatory waves. On one hand, buy-side firms might favour existing non-triparty custodians (aka. third-party custodians as per the dedicated market terminology) which made sense on paper, as these firms tend to benefit from a wide range of services from their primary service providers. On the other hand, the clear operational and optimisation benefits of triparty services meant that buy-side firms might see the advantage of establishing triparty relationships, sometimes away from their primary custodians and depositary banks.
We firmly believed in the latter and, at least in Europe, this has already materialised for wave 5 (September 2021). To think that the market would mostly rely on third-party custodians for wave 5 was underestimating the benefits of the triparty model and also the sell-side’s appetite for a more coherent model across the board. To a certain extent, brokers have a vested interest in capitalising on their investments in triparty models and building a robust straight through processing model such as triparty.
With wave 6 (September 2022), which applies to a much larger population of market participants, we believe we are set to see the continuation of this trend and a wide adoption of triparty models to manage initial margin.
Pushing the boundaries of eligible collateral
The collateral landscape is evolving and becoming more diversified by geography and asset type. This includes what was considered ‘non-standard’ collateral, such as ETFs[1].
In the case of ETFs, we have not seen a wholesale move to their use in collateral management thus far. This is because the characteristics of these instruments, including the questions around their rating (HQLA[2] vs. non HQLA), whether they are synthetic or physical, and whether they are ETF groups or list of individual ETFs, contribute to the complexity of their management as collateral. However, better and more coherent data, will facilitate the treatment of these criteria and allow for a broader use of ETFs as collateral going forward.
The future of collateral will be digital and sustainable
When it comes to sustainable or ESG compliant collateral, our asset manager and asset owner clients can expect us to be able to support them in fine-tuning their collateral policies according to their ESG standards. As the definition of ESG baskets is still remote, we have initially focused on supporting our clients with custom solutions. This entails the inclusion or exclusion of specific assets or industry sectors, and the ability to guarantee a proportion of ESG compliant assets received as collateral.
Recent discussions at market levels (e.g. International Securities Lending Association, Global Principles for Sustainable Securities Lending) tend to confirm the challenge to define commonly agreed ESG collateral baskets which validates the need for custom solutions in the meantime. But agreed definitions will happen, and this is where service and data providers must act collectively to aim towards standardisation.
With regards to digitalisation of collateral management, there are of course a myriad of possibilities. Certainly Distributed Ledger Technologies (DLT) and tokenisation are two areas that are being discussed quite broadly. Digital solutions can help answer real market needs such as interoperability, capital consumption and collateral silos. This is why we decided to participate in HQLAx, which leverages R3’s distributed ledger technology, Corda Enterprise, to enable market participants to transfer ownership of securities seamlessly across disparate collateral pools at precise moments in time to optimise their liquidity management and collateral management activities. This is where digital technologies can help boost operational efficiency gains and capital cost savings.
[1] ETF: Exchange Traded Fund
[2] HQLA: High-Quality Liquid Assets
