Basic HTML Version
Opportunities and Challenges for Hedge Funds in the Coming Era of Optimization
|
5
liquid assets (HQLA) are down significantly. Markit
puts utilization of lendable government securities
at 33.7% at the end of Q1 2014 versus 55.9% at
the end of 2007. With use of this supply down so
sharply, several survey participants noted that
they have insourced both their cash reinvestment
and the repo portion of their traditional agent
lending bundle and are instead allowing their
internal cash management team to access this
supply to supplement their repo and reverse
repo programs.
Regulatory changes being implemented post-GFC
may have the potential to further narrow the pool of
asset owners willing to put their supply out on loan.
Rule 165(e) of the Dodd-Frank Wall Street Reform
Act and Basel III- related regulatory changes may
force agent lenders to re-evaluate their provision
of indemnification against borrower default and
potentially look to charge for this coverage or remove
it as an option. The decision as to whether or not
to provide indemnification may be complicated by
new counterparty concentration rules that seek
to limit the overall amount of exposure any single
counterparty can have to any other counterparty.
Custodial banks that offer indemnification will have
to include their securities loan exposures as part of
such calculations. For custodial banks with affiliated
broker-dealers, the combined exposure across
both parts of the organization will be considered in
applying proposed limits.
Against this backdrop, new solutions are emerging
to enable asset owners to pursue a broader set of
options that would allow more routes to market to
fully utilize their supply. Agent lending is a key part
of the emerging solution, but to provide asset owners
additional choices, market leaders are taking a more
client-centric approach. In the emerging model, the
asset owner can work with a “solutions” expert in
the sales organization that understands the entire
breadth of the potential demand pool. This expert
can help the asset owner allocate their portfolio
and direct their assets toward the best demand pool
across agency, principal or synthetic lending. Each
of the teams in those areas would then utilize the
supply as fully as possible, while maintaining their
independence and appropriate separation around
Chinese Wall restrictions. This gives the asset owner
the flexibility to work with multiple areas of the
organization without having to exclusively direct their
assets to solely one team.
This concept of “supply optimization” is also
expanding to incorporate using portions of the asset
owner’s portfolio as collateral against derivative
trades. Title VII of the Dodd-Frank Act and the
European Market Infrastructure Reform Act (EMIR)
have dramatically altered the way that clearing of
OTC derivative transactions will occur. The amount
of margin required to cover these transactions is
expected to skyrocket. In the first nine months of
mandated derivatives clearing in the U.S., the amount
of collateral held in customer segregation has already
climbed by 64% according to the National Futures
Association. Almost all of the collateral expected to be
posted against these obligations is high quality liquid
assets (HQLA) -- the same government securities
sitting unutilized in many lending programs today.
An ability to advise asset owners on how to optimally
direct different portions of their supply across a mix of
agency, principal and synthetic lending opportunities
as well as satisfy collateral needs should help reduce
the overhang of unutilized supply in lending programs,
improve overall margins, create efficiencies for clients
that participate in these programs and meet demand
from investors looking to deploy strategies in the
convergence zone.
A sub-set of asset owners interviewed for this year’s
survey indicated that they can achieve these same
goals by optimizing their use of assets within their
own organization. These investment managers are
typically running a mix of traditional and alternative
strategies. They recognize the potential to centralize
their liquidity management to better deploy their
pools of cash, HQLA and other securities rather than
having diverse groups each administering their own
pool of such supplies in a fragmented manner. In
these instances, the asset manager will insource all
three components of the traditional agency lending
program—stock loan, repo and cash reinvestment.
The complexity of bringing these capabilities in-
house and creating these internal teams is not to be
understated, however, and the consensus from survey
participants was that the majority of asset owners
would instead look to sell-side providers to ensure
their ability to optimize supply.