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Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
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39
Lending CCPs Could Be Used as
Collateral Optimizers
Support for the idea of trading via a central
counterparty was much more muted across the set
of survey participants. Yet, some saw potential for
these venues to be used to broaden the demand pool
and for providing an outlet for GC trades that would
otherwise be left sitting in custody.
In a bilateral trading model, the creditworthiness
of a selected counterparty is a key consideration.
Asset owners have extensive requirements and often
choose to limit their lending pool to a select group
of borrowers that have gone through a rigorous risk
assessment. Many entities that may be interested
in holding general collateral fall outside the risk
parameters of this assessment. Hedge funds and
even some sovereign wealth funds may be unwilling
to provide the required level of transparency to be
viewed as a reliable counterparty in the current
bilateral model.
In a central trading model, this would be less of a
risk for the asset owner. Their exposure would be to
the CCP, not to the counterpart. This could help to
bring a broader set of borrowers into the market and
help to expand the demand pool to absorb some of
the overhang of general collateral sitting unutilized
in the lendable supply pool. Some of the new
participants could even provide a demand outlet for
illiquid securities that would be hard to loan in other
circumstances—thus facilitating the transformation of
those assets.
Perhaps even more importantly, these venues could
provide asset owners sitting on large pools of cash
an opportunity to secure high quality liquid assets
(HQLA) to meet collateral obligations, but with
less risk than entering into bilateral reverse repo
contracts. The cash that asset owners post in these
transactions would be guaranteed by the CCP, making
this a potentially easier sell to internal constituents.
As will be discussed in the next section, demand for
HQLA is expected to surge in the coming years due to
OTC derivatives reform.
“ CCPs may provide an alternative route to market for
other types of principals that are hard to get into the
market. This could include sovereign wealth funds
out of the Middle East where credit and domicile
risk might be an issue in normal circumstances
but could be less of an issue going via a CCP,”
— Industry Trade Organization
“ If a CCP had a very good risk waterfall that they
can articulate and show so that people can get
comfortable with the risk element of a CCP
and at the same time have enough liquidity
trade over the CCP then the agent lender and
beneficial owner could go direct to the CCP
then there is a potential model that works,”
— Agent Lender
“ I think the CCP conversations are a bit premature.
The old models are not effective but it may become
necessary in the future,” — Agent Lender