Trends in collateral management 

In a video interview, Global Investor engaged in a conversation with Eileen Herlihy, managing director and global head of trading services sales along with Will Jeffries, executive director and APAC head of trading services sales at J.P. Morgan, to explore the latest developments and share their exclusive insights for collateral management. 

The full discussion is available in the video above. See below for a transcript of the highlights. 

Amelie Labbe-Thompson (AL): Hello, and thank you for tuning in. I’m Amelie Labbe-Thompson, the Managing Director of Global Investor ISF. What you’re about to listen to is part of the 2024 edition of the collateral management Guides and features exclusive insights from J.P. Morgan’s Eileen Herlihy and Will Jefferies.

William and Eileen, over to you.

William Jeffries (WJ): Good morning. Good evening, everyone, depending on where you are in the world. Thanks for joining us today. My name is Will Jeffries, and I’m responsible for APAC Trading Service’s Sales here at J.P. Morgan. Specifically encompassing tri-party collateral management.

With me today is Eileen Herlihy, Global Head of Trading Services Sales, also at J.P. Morgan. Today, we will be discussing the top trends in collateral management as part of the Global Investor Collateral Guide as we enter 2024.

Good morning, Eileen.

Eileen Herlihy (EH): Hello Will, I have to laugh that this is a fireside chat. Given how many thousands of miles we are away from each other. But it’s good to talk.

WJ: Absolutely. Just to get things started. Can you please just give me a quick overview of what your role is and what J.P. Morgan Trading Services is?

EH: Yes, I think that the term Trading Services is a bit of a J.P. Morgan specialty term. We mean our Agency Securities Finance and Collateral Services businesses. We brought these businesses together in 2017, as we felt that it was much more holistic to look at these businesses together, given that we saw a lot of convergence and similarities across both these product sets. So, it made sense to bring them together and I run sales for Trading Services on a global basis.

WJ: Okay, perfect. Thanks very much for that. Now, J.P. Morgan recently conducted a survey with our clients, and one of the key questions we asked was, “What is your focus for collateral in 2024?”. The top three responses by quite some margins were - optimisation, new markets and new counterparties, all in that order.

Does this surprise you at all?

EH: No, it doesn’t. In fact, if optimisation wasn’t on top of the list, I would have been shocked. In fact, I wonder if in any year we wouldn’t have had optimisation in the top three as something that our clients care about. If you look at the landscape in which our clients operate, clearly managing their balance sheets, their liquidity and their capital are key things that they have to do on a daily basis.

It’s been such a strong theme and people have been on different parts of that journey since the global financial crisis in 2008. The sell side has been very much at the forefront of this through setting up centralised funding desks, bringing together businesses that have traditionally operated in different silos to make sure they’re looking at their collateral optimisation holistically.

Our job as tri-party agent is to help them manage that in whatever process works best for them. Some clients want to completely do everything in-house, and we really need to provide the operational infrastructure around that.

Alternatively, some clients need help, and they need us to help more directly in terms of how they build that optimisation engine.

So, we’re really there to support them. And then of course, new markets, new venues and new liquidity. These are topics we can talk about later, but have all been themes for optimisation for several years.

WJ: So potentially what we can take from optimisation for the sell-side, is that the job is never really done. How about the buy side?

EH: That’s very interesting. Finadium released a survey at the end of last year which stated only about a third of large global asset managers have centralised funding desks or cash desks. If you think about it, this is quite low in comparison to the sell side, where I imagine the number is nearer to 90% or 100%. The buy side has been very focused in recent years with the implementation of the Uncleared Margin Rules (UMR) as the various phases work through the system. Going into 2023, we thought that this would be a year where the buy side could be given a little bit of respite. However, the gilt crisis at the end of last year in the UK was quite an eye opener for a lot of the U.K. buy side. And quite frankly, it’s something that we talk to clients all around the world about.

As one client recently said, “We had plausible deniability the first time around. But if anything like this were to happen again, we need to be able to demonstrate that we’ve optimised our collateral processes.” So, it’s caused a lot of reflection with our clients and we’re starting to see them focus more and more on collateral optimisation and efficiency. We recently pulled some stats from our tri-party programme looking at the composition of collateral posted by our buy side clients. As recently as two years ago, in July 2021, 90% of collateral being posted by the buy side was government bonds.

Fast forward to two years later in July of 2023, that number decreased to less than 50%. What we’re seeing now is buy side clients posting about a third of their margin in corporate bonds and then about 20% in equities. We’ve seen a very dramatic shift, in quite a short time frame.

WJ: That’s great colour, and it’s interesting to hear the key differences between the buy side and the sell side.

EH: I want to turn things back on you, Will, it shouldn’t have to be me answering all of the questions! We talked about the optimisation of new markets and new liquidity being important, but of course, you are on the ground there in Asia. Can you tell us what you’re seeing from a new market’s perspective there?

WJ: Asia is unique in that each jurisdiction has different rules and the region has a significant number of restricted markets. What that really means, is that many of these markets require innovative solutions to be able to support them as collateral and ultimately allow our clients to optimise their balance sheets. What’s interesting with these markets is that many of them, despite being considered developing markets, are very large and important markets that clients either have substantial holdings in or see significant opportunities.

When many of our clients look at their unfunded assets, a large percentage of these are sitting within Asia and can quite often considered trapped assets that can’t be financed or are difficult from a collateral mobilisation perspective. So they become a key focus.

EH: Interesting you say that, because I was talking to one of our US colleagues last night and comparing the amount of asks we get from clients on the Asian side versus, say, the LatAm markets; but it’s fair to say that when we go out and meet clients that it is Asia that dominates.

Can you be a bit more specific around which markets in Asia you’re seeing the most interest in?

WJ: It’s probably no secret about the areas we’ve been focusing on, and it is ultimately well aligned with our clients and their activity. South Korea, Taiwan, China and Stock Connect are all key markets that we’ve invested a significant amount of time in over the years, and that’s really been beneficial for our clients in helping them mobilise their assets.

Looking forward to 2024 and certainly in the current interest rate environment, we suspect that there’s going to be a lot more pressure on unfunded assets. We’re fielding many questions on new markets and some of these are China onshore, India, Indonesia, and Malaysia, just to name a few.

So that’s really what we see as being a key focus from our clients. I also want to mention that it’s not all about APAC. There are markets in EMEA, that we hear about as well, such as Saudi, Turkey and Israel as an example. Ultimately the challenge that we all face is that these markets have very different requirements and they really do require significant innovation.

EH: As you mentioned, these aren’t simple markets and it’s all very well and good that the borrowers have these unfunded assets that they want to be able to utilise, but what about the lenders? What’s in it for them? Why should they have to go through some such complex processes to bring in new collateral to the programme? Can you talk about the supply and demand dynamics with these new markets?

WJ: We’ve been seeing increasing interest from lenders to expand collateral, and again, that’s not a new trend, but it’s certainly something that’s been developing over the last few years and that’s really when returns are hard to come by. When supply outstrips demand, new markets can really act as a lever to extract further yield from lending portfolios.

So that’s one of the key focuses and one of the reasons our lending clients are looking at these markets, but they also provide a key differentiator for lenders. Lenders do need to satisfy themselves with the enforceability aspects of new markets.

Given that many of the Asian markets are restricted, this includes being comfortable with pledge solutions but also looking at liquidation models that ensure that they can quickly and efficiently liquidate collateral should the need arise.

Once lenders are comfortable. There are also considerations on whether they are being compensated against the risk that they’re taking from a new market, particularly when the collateral might not be widely accepted by other lenders.

EH: Yes, but of course that’s incumbent upon the lender to extract the maximum value for that as well. Shall we move on to pledge now? You have talked about it quite a bit and from my perspective, we’re always wondering, is the next year coming going to be the year of Pledge?

It was 2018 when ISLA came out with their pledge GMSLA. If you look at from a European perspective, about 17 to 18% of collateral is posted under a pledge, and it’s been at that level for quite a while now and I would expect that number to be a little bit higher.

Lenders must satisfy themselves that any collateral that’s posted under pledge meets local perfection requirements. But it is one of those topics that we talk to clients a lot about. Of course, there are challenges with Pledge - Does it work for UCIT funds and of course there are challenges for American borrowers.

If I was to try and predict themes for 2024, from a recent borrower and lender roundtable that we ran here, it seems that there was consensus around the table that they wanted the industry associations to focus on Pledge Back type of structures, and see if we can get some documentation in place to enable these structures to be more broadly used.

So, pledge and variations of pledge, I definitely think will be a theme for 2024.

WJ: That’s certainly consistent with what we’re seeing in Asia.

Now the third top response to our survey for 2024 was new counterparties. You also mentioned new venues as part of the sell side approach to optimisation. Can you just expand on these two points for me?

EH: I might skip the question on new counterparties and spin that one back to you, but I’m very happy to talk about the new venues. To be honest, this is multifaceted and CCP margining though tri-party is a topic close to my heart. I used to work in our clearing business here at J.P. Morgan for the past 10 years before coming into this role and what we’re seeing in our clients, especially organisationally, is a lot of clearing and prime businesses coming together, and as we talk about this never ending journey of optimisation, people are saying, “I love Triparty for my stock loan and my repo, but why can’t I also use it to optimise my collateral at the CCPs?”.

Just to put it into context, there is about one trillion of margin held globally at CCPs. About 30% would be bank assets, and then the other 70% would be client assets. So, a non-trivial amount of margin that needs to be optimised. We are working with our clients across the globe to see if we can facilitate margining using a tri-party long box to deliver collateral to the CCP.

Of course, many clients welcome that because there is a lot of operational integration that needs to be done with each of the CCP’s. We have a mechanism where we have worked with a third party to facilitate the ease of integration.

WJ: What are you seeing from the CCP’s themselves? Are they ready to take non-cash collateral and how are they adapting to this?

EH: CCP’s accept non-cash collateral today, but there is a lot of inefficiency within the margining process. We are working with many of them, and I think there is an appetite to accept a certain amount of non-cash collateral, but one must also be mindful that the economic model for many CCP’s is that they generate a lot of their revenue from cash collateral.

I’m going to throw it back to you now on new counterparties. Do you want to tell us about what we’re seeing in Asia?

WJ: New counterparties are extremely important to the to the entire financing ecosystem. It’s particularly important for us as a tri-party agent because it creates a network effect for our clients. New lenders provide liquidity enhancement through introducing new sources of funds or securities which can help with overall liquidity of the market.

In instances of new borrowers, they provide new demand, which ultimately leads to better price discovery as pricing becomes more reflective of the market conditions. Perhaps most importantly, new counterparties provide optionality and diversification. This is particularly important for all our clients as they manage regulatory requirements and look for different counterparties with varying profiles and funding sources.

EH: What’s interesting about that, as we go and develop new counterparties throughout the book is the ability for them all to be able to trade with each other. Can you talk a little bit about how we focused on our global operating model?

WJ: J.P. Morgan has for a long time operated a tri-party system which has allowed clients to exchange collateral on one global system. We’re now starting to take that a step further. We have certain instances where collateral is operating in different environments. In Australia, as an example, we have an Australian onshore platform that contracts under Australian law and through our Sydney branch. In the US we have a U.S. platform and that’s contracting with our New York branch and it’s these various environments which have always been there and existed for local reasons, such as local contracting requirements.

I’m going to talk about this a little bit later, but we’re seeing a lot more regionalisation with local counterparties who want to open and trade with more global counterparties. So, we’ve had to think of ways to adapt to that. We have worked on a new legal process, where not only can clients exchange collateral freely on our international platform today, we’re now looking at how they can do that from our international platform to our Australian platform or from our Australian platform back to the international platform. This is really important where the U.S/ EMEA might be operating, and Australia might be asleep, but clients need to tap into various sources securities collateral which they can move across entities and time zones in a frictionless environment.

So again, from that perspective, it’s all about collateral mobilisation.

EH: Okay, thanks for that. I’m sorry I may have interrupted your train of thought. Should we go back to what we’re seeing specifically from an Asian perspective with new counterparties?

WJ: Yes. I think I was talking about optionality and diversification. It’s no longer necessarily about the loan and the spread of the transaction. And it’s been like this for a long time. Borrowers particularly are working towards complex metrics and that might include, types of counterparties and specific types of collateral, depending on their binding constraint.

That may be LCR, NSFR or certain Risk Weighted counterparties. Lenders are in a similar position, particularly when indemnification is involved as an example. So that’s really where counterparty diversification becomes important. I think it’s becoming more important moving through to 2024. In the rising rate environment, we’re starting to see clients lose that access to cheap funding that they’ve had in the past. They will no doubt be starting to look towards the secured funding markets to take some of the capacity they require.

EH: From your perspective, are we seeing a lot more entrants to the market in Asia? WJ: Asia continues to be an exciting place. It wasn’t that long ago that the Asian triparty financing space, was predominantly the global investment banks utilising APAC collateral with the major global agent lenders, and it wasn’t uncommon for people to question where all the APAC counterparties were.

We are certainly starting to see a shift there now with more, internationalisation as new regional counterparties explore the benefits of tri-party. That’s not to say that there haven’t been local counterparties active in Asia, because there always has been, only they’ve been focused on their local markets. From a collateral perspective, that’s been concentrated on local cash and local securities from a bilateral perspective specific to their market.

New regional counterparties are really starting to realise the benefits of triparty. Triparty provides a powerful tool that allows them to further grow and scale their business, and that’s in several different ways. That’s realising automation and operational efficiencies, which is at the heart and the basics of tri-party, accessing and trading with a new network of cross-border counterparties, utilising and accepting a broader range of securities despite time zone challenges and finally, the widening of collateral schedules - this is a key thing that we’re seeing in Asia where there might be wrong way risk that’s inherent in some of the local markets, but it also gives lenders the opportunity to search for further yield opportunities. Meanwhile, global borrowers can access new supply of securities and new liquidity, and global lenders can open new distribution channels of demand.

So, a final prediction for 2024 is that we’ll continue to see new counterparties into the tri-party financing space, but it’s also worth mentioning that this trend isn’t just specific to Asia. It’s something that we’re seeing across all three regions that we support .

EH: That’s interesting. Finadium had some stats that I saw recently where they estimate the amount of assets in tri-party is about 6 trillion and it went from 4 to 6 trillion in the last two years. But if you look further back, it took about seven years to go from 2 to 4 trillion. So, the rate of increase in adoption is quite exponential.

WJ: We are starting to run out of time. However, I have one more question for you that I’d like to ask, and it’s on the topic of tokenisation, something that we’ve been hearing and reading a lot about. Obviously, J.P. Morgan is very active in expanding this space, but when I look at this survey that we sent to clients, it’s scored quite lowly in terms of client priorities for next year. What are your thoughts about this?

EH: Great question. I think it’s fair to say that I’m probably more bullish on tokenisation than some other people, and maybe that’s because I’m not at the coal face of having to actually integrate it, but I spoke on a panel at ISLA in June and the title of the panel was “It’s All About Collateral”, and there was a combination of sell side and buy side there where I, out of all the people on the panel was the most bullish.

So why am I bullish? Because there’s so many use cases and I could spend hours and hours talking about it, but if I talk about the use cases I find the most exciting. Firstly, it’s around tokenising for the purposes of margin which is very powerful.

If you look especially in the clearing landscape where as I mentioned earlier, transfer of margin is not the most efficient, whether it be for the CCPs, intraday margin calls to the clearing brokers or whether it’s clients who have to pre-fund margin to the clearing houses in Europe to be able to trade, tokenisation could simplify and improve the operational process so well.

Secondly, tokenisation brings new assets into the funding landscape that weren’t traditionally easy to access. Case in point, money market funds, and that’s something that we did as a use case on last year and showed that you can transfer money market funds as collateral and then I think the third thing with tokenisation, of course, is that it reduces gap risk or credit risk.

If you look at what HQLAx is doing, where they’re working towards delivery versus delivery. Tokenisation mitigates risks in these typical crossborder trades that you have of treasuries versus JGBs. So to me, why wouldn’t everyone want to embrace this? Now, in reality, of course, there’s no market consensus on what type of blockchain to use, and ultimately investment budgets are constrained.

Everyone is trying to figure out if there is a benefit to being a first mover, or which horse they should back. So, I get it. There are many competing priorities, but I really hope when we rewatch this video in a year’s time that my prediction that tokenisation will have outperformed people’s expectations will hopefully come to pass.

WJ: Yeah, I think the benefits are undeniable, we certainly see that, and I think there’s a lot more development to come.

Well, thank you Eileen. It’s been fun to chat with you through what we see as the trends for 2024. Optimisation remains a key theme and something that our clients will continue to expand on. So thank you very much for your time. And to our listeners, we hope you found these topics interesting.

AL: Thank you very much for listening and I hope you enjoyed the conversation.