Collateral Management – Overview of the International Regulations Luigi Concistre’ Banca d’Italia/ Italian Embassy in Moscow

Collateral Management Collateral Management, an area, once seen as an ancillary, is now seen as a thoroughly main-stream and important regulatory compliance framework

Collateral Management 1. Evolution of Collateral Management Why? 2. Different legal and regulatory frameworks 3. Collateral Management 4. Framework in the Eurosystem

1. Evolutions of collateral management: Growing importance Before the collapse of Lehman Brothers in 2008, the markets had been relatively free of turmoil and liquidity was both plentiful and easily acquired.

Collateral Management: Growing importance This change was brought about by two main identifiable factors. First, the concept of trust in the interbank markets evaporated; financial institutions were swept up in the ‘flight to quality’ phenomenon, hoarding their high-grade and liquid collateral reserves. Second, regulators around the world began to address the difficult task of restoring public confidence in the financial sector.

Collateral Management Collateral was viewed as both a solution to and a trigger of massive financial losses that occurred as a result of the financial crisis of 2008. The regulatory reforms triggered by the current crisis have, among other things, resulted in an increase in demand for collateral. The regulatory reforms have taken different paths.

Collateral Management The financial crisis has been a driver for central banks to adjust their eligibility criteria for collateral, as have market developments which have urged a shift from unsecured to secured funding and thereby greater use of collateral. Meanwhile, financial regulators worldwide have cooperated on the topic of regulatory reform to address flaws in the financial sector, in particular as regards liquidity and risk management. I In view of these developments, internationally active financial institutions are faced with complex and often diverging collateral requirements across borders and frameworks.

Collateral Management: Growing importance OTC derivatives were identified by regulators as an unquantifiable and thus unacceptable source of risk. To address the issue, an attempt was made to tackle the problem by requiring the bulk of OTC derivatives trading to occur within the - arguably - safe confines of a risk-averse central counterparty (CCP) serving as an intermediary and risk-centralising agent, governments hoped to quantify and thus exert a degree of control over the risks impacting the capital markets

Collateral Management: Growing importance G20 Evolution Mandatory clearing BCBS internationally consistent, risk sensitive rules for capital treatment for banks engaged in shadow banking activities - mitigate banks' interactions with shadow banking entities. FSB - recommendations on minimum standards on methodologies for calculating haircuts on non-centrally cleared securities, developed information-sharing process within its policy framework for shadow banking, and proposed standards for global data collection regarding repo and securities lending markets.

Collateral Management: different approaches Central bank collateral frameworks: broadest eligibility criteria 2. Under the regulatory prudential frameworks – es. European Market Infrastructure Regulation (EMIR) in the EU and the Dodd-Frank Act (DFA) in the US, as well as the Committee on Payment and Settlement Systems and International Organization of Securities Commissions (CPSS-IOSCO) principles for financial market infrastructures (PFMIs) and Basel III at global level – more restricted types of assets are deemed eligible. 3. CCP frameworks are the narrowest of the frameworks considered as regards acceptable margin collateral.

Central Banks

Regulatory Frameworks

Regulatory Frameworks (continued)

Regulatory Frameworks (continued)

CCP Frameworks

CCP rules

Collateral Management Differences in the collateral frameworks: type of assets accepted as collateral collateral denominated in foreign currency additional requirements for collateral

Collateral Management type of assets accepted as collateral almost all frameworks accept debt securities issued by central governments/central banks and cash, with covered bonds also being accepted in many frameworks. Other marketable assets – such as debt securities issued by credit institutions, as well as corporate bonds and asset-backed securities – are accepted mainly in central bank frameworks, while equities, bank guarantees and gold are generally only eligible within some regulatory frameworks and only to a certain extent, as well as for the margin collateral of some CCPs and for non-centrally cleared over-the-counter (OTC) derivatives.

Collateral Management 2. collateral denominated in foreign currency These assets are accepted by all central bank frameworks considered (although in certain cases, they are only accepted on a very limited and temporary basis) and for the margin collateral of CCPs. Regulatory frameworks take restrictive approaches to accepting assets denominated in foreign currencies, only allowing the use of such assets for CCPs if the respective CCP is able to manage the risk related to the currency and the collateral is limited to the currency in which the CCP clears contracts. In general, only major or regionally linked currencies are accepted.

Collateral Management additional requirements for collateral minimum credit rating and/or guarantees from central government. valuation haircuts may be applied. Distinctive similarities and differences can be found in the following requirements. First, minimum credit standards are broadly established by many central banks and CCP frameworks, although reliance on external ratings is diminishing. In general, the range of credit standards accepted differs across frameworks. Second, minimum haircuts apply to most frameworks, but with levels differing according to the type, maturity and creditworthiness of the collateral assets.

Collateral Management Harmonisation/ Diversification a certain degree of diversification across the collateral frameworks may be seen as a positive element that enhances resilience, provided that some conditions are met in relation to the transparency of the collateral frameworks, clarity of regulatory requirements and availability of collateral.

Collateral Management Transparency Important that: transparency on the different frameworks is provided on an ex-ante basis and that such information is kept as up to date as possible 2. regulatory frameworks are clear 3. authorities provide guidance where needed is important for the acceptance of collateral Major differences in the interpretation of what is meant by “highly liquid” or “highly reliable” may lead to major discrepancies in the risk management framework that would not necessarily be justified.

Collateral Management The existence of different collateral requirements also increases the need to have effective procedures for enhancing collateral availability, such as the development of links and interoperability, as well as for collateral transformation services. While the latter can help in having collateral available where needed, they also have the potential to create new risks and instability.

Collateral Management Collateral transformation services are mainly being developed to transform ineligible collateral into eligible collateral (e.g. enabling participants to borrow government debt securities against corporate bonds or other collateral, which could then be accepted as collateral by a CCP). Different types of underlying transaction could be involved in these collateral transformation services, e.g. securities lending, repos, swaps, etc. Additionally, simultaneous transactions could be conducted, or two independent transactions could take place (e.g. involving a repo anda swap).

Collateral Management Haircut practices, such as valuation haircuts, differ across collateral frameworks and also tend to change (e.g. in times of market stress). Haircuts differ because of the need to balance a number of elements, such as the soundness of the collateral taker or collateral giver, the availability of adequate collateral and the need for flexibility to adapt to changing market conditions. In addition, regulatory requirements have been introduced regarding haircuts.

Collateral Management: Growing importance Main Problem collateral scarsity (??) maybe not.. the real problem is collateral fragmentation

Collateral Management: Growing importance The prevailing collateral theory of ‘supply being sufficient to meet demand’ depends on firms being able to source their inventories in a centralised and efficient manner. Unfortunately, the capital markets are far from perfect and there is genuine concern that there will be mismatch between where the high-grade collateral is held and where it is needed

Collateral Management: Growing importance The need for centralised inventory management to meet an increasing number of cross-border collateral demands has begun in earnest. A new holistic approach to inventory management with coverage across collateral silos and geographic locations is becoming the new norm as capital market participants strive to ensure no asset in their inventories sits idle. The only way to survive, is to make all available capital reserves sweat i.e. fully utilise their potential

Collateral Management: Growing importance Lenders have resorted to asking for, and getting, more complex collateral schedules as an alternative to receiving highly rated securities collateral to secure their loans. This has led to the propagation of the ‘collateral upgrade’ services which have long been a staple of the capital markets. Most repos are nothing more than an upgrade or a bond-borrowing transaction. Under normal market conditions, such transactions happen all the time and in great quantity

Collateral Management: Growing importance The systemic risk implications of collateral upgrade trades during distressed market conditions are now getting the attention of the regulators – and rightly so.  Will they recommend or mandate that securities lending transaction also require a CCP, just as they have done for OTC derivatives?  Our guess is that the transparency they seek – through more frequent and regular reporting of transactions like securities lending upgrade trades – will be the first mandatory step in that direction, meaning that central trade repositories for securities lending may well be making their appearance in the not-too-distant future.

Collateral Management in the Eurosystem The CCBM The correspondent central banking model was introduced in January 1999 in order to ensure that all assets eligible for Eurosystem credit operations could be used as collateral by all Eurosystem counterparties, regardless of the location of those assets or counterparties.

Collateral Management in the Eurosystem Eligible links between SSSs (i.e. links considered to meet the ECB’s standardsas regards the use of EU-based SSSs in Eurosystem credit operations) constitute an alternative to the CCBM for the cross-border use of marketable assets. Though the use of links has increased over the years, these have played only a secondary role.

Collateral Management in the Eurosystem Eurosystem counterparties may obtain credit from the NCB of the Member State in which they are established (their “home central bank” or “HCB”) by making use of eligible assets located in another euro area country.

Collateral Management in the Eurosystem Since its introduction, the CCBM has been the main channel used for the cross-border delivery of collateral in Eurosystem credit operations. The value of cross-border collateral transferred via the CCBM has, with some variation, increased over the years, standing at €163 billion in December 1999 and €569 billion in December 2009. In December 2009 the CCBM accounted for 25.1% of all collateral transferred to the Eurosystem in value terms.

Collateral Management in the Eurosystem the Governing Council of the ECB decided in March 2007 to review the Eurosystem’s collateral management procedures – particularly the CCBM. A medium-term project to establish the next generation of collateral management was then launched in July 2008 under the name “Collateral Central Bank Management”.

Collateral Management in the Eurosystem The CCBM only provided for the cross-border delivery of collateral, while each national central bank had its own procedures for the use of domestic collateral. The scope of CCBM2 went beyond that of the CCBM, as it aimed to establish efficient procedures for the mobilisation and management of collateral for both domestic and cross-border use.

Collateral Management in the Eurosystem The main objectives of CCBM2 was to increase the efficiency of the Eurosystem’s collateral management and address the drawbacks identified by market participants with regard to the CCBM framework, to the extent that these fall within the remit of central banks. CCBM2 will be able to adjust to changes in the Eurosystem’s collateral and operational frameworks – as well as market developments – in a smooth and swift manner.

From CCBM to CCBM2: what should have remained Pooling management auto-collateral at the CCD (in Italy: Monte Titoli) Real time disposal of collateral and management of depository services Possibility to use another bank for the transfer of collateral and/or the T2 settlement of monetary policy operations

CCBM2:New Functions harmonized interfaces for communication with the Eurosystem (SWIFT and the Internet, U2A and A2A); monitoring of positions at the level of individual banks and banking group; ability to transfer guarantees, domestic and foreign, to foreign custodians chosen by the counterpartpart (removal of the repatriation requirement) use of triparty cross-border services

Collateral Management: Growing importance POOLING In June 2010, It was introduced in Italy the pooling of callateral, based on the pledge. It allows banks to provide guarranty to a plurality of financing operations BENEFITS FOR THE BANKS 1. Simplification of the back-office 2. Flexibility and optimization of the use of collateral 3. Simpler Dialogue with Supervisor

From CCBM to CCB2 The Governing Council of the European Central Bank (ECB) has decided to discontinue the preparations for the Collateral Central Bank Management (CCBM2) project in its current form. In the project detailing phase, a number of challenges in the field of harmonisation were identified and the Eurosystem has decided to address these issues first before proceeding further with a common technical platform. The existing Correspondent Central Banking Model (CCBM) for cross-border collateral management remains in place.

Eurosystem New Framework The Eurosystem has concentrated on implementing the previously announced enhancements to Eurosystem collateral management services within the CCBM 1. removal of the repatriation requirement from the CCBM 2. support of cross-border triparty collateral management services. Both enhancements has been introduced in the Eurosystem collateral management framework in the course of 2014. Furthermore, the Eurosystem will prepare for the support of T2S auto-collateralisation procedures.

Cпасибо! luigi.concistre@esteri.it Bankitalia.mosca@esteri.it