Sovereign Wealth and Pensions Enticed by Collateral and CP Business
With expanded capital restrictions, especially when it comes to derivatives, traditional banking institutions are dealing with tighter balance sheets. The European Market Infrastructure Regulation (EMIR) and U.S. Dodd-Frank Act have modified the requirements for clearing and collateral. These laws promote the central clearing of standardized over-the-counter (OTC) derivatives contracts. The forced move toward central clearing is feeding a manufactured hunger for more high-quality securities to be used as collateral. Another source of collateral besides banks are sovereign wealth funds and pensions, many which possess massive inventories of high-quality securities. These asset owners are becoming sources of liquidity and typically search for yield opportunities any way they can.
Links between banks and non-banks would become further blurred.
Tail Risk Capital for Counterparties
In late March, the California Public Employees’ Retirement System (CalPERS) finalized a deal in which the pension giant partnered with agency securities lending provider eSecLending LLC to make a 1-year repurchase (repo) facility. CalPERS gets paid for backing the repo facility, enhancing the system’s cash return. Essentially, CalPERS and eSecLending would provide Chicago-based Options Clearing Corporation (OCC) a cash draw from CalPERS if a counterparty defaults on a derivative trade. OCC is serious on diversifying its liquidity base which traditionally relied on large banking institutions. John Fennell, Executive Vice President of Financial Risk Management at OCC explains how these arrangements enhance cash returns, “For the fund, they are able to invest in short-term investment funds on an overnight basis while earning a commitment fee from the borrower of the funds. If the lines are ultimately drawn on, the fund earns a higher rate to compensate for the inability to invest the funds overnight.”
Sovereign wealth funds, an institutional investor market surpassing US$ 7 trillion in assets, are a natural source of capital for these types of arrangements. Fennell adds, “I think the aspect of pension funds that makes them attractive to central counterparties is their cash flows that are controlled and not susceptible to runs by clients during times of crisis. Sovereign wealth funds have very similar characteristics which would presumably make them a great alternative for this type of investment. Also, given the size of sovereign wealth funds, this could add a material inventory to the liquidity supply that might be accessible to central counterparties.”
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