Get Collateral Moving, Says EU Trade Group

(November 16, 2012) — Too often collateral is in the wrong place at the wrong time, according to a white paper by members of the European Union-based International Capital Market Association.

The authors of the paper foresee the demands of high quality collateral significantly outstripping supply in the future, and urge that it be treated as a scarce resource.

With demand and requirements up, the paper argues that IT infrastructure in the Eurozone is no longer up to the task of mobilizing assets and matching them with transactions.

“More attention urgently needs to be given to collateral fluidity, which in essence concerns the mobilisation of collateral, i.e. allowing it to be in the right place at the right time,” says the paper, which was produced by the Collateral Initiatives Coordination Forum, a subgroup of the larger trade association. “Achieving this requires that the plumbing be properly fixed, including through finally making progress with the continuing Giovannini barriers to EU cross-border clearing and settlement arrangements.”

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Since the financial crisis, collateral has been an increasingly important tool to protect against counterparty risk.

“This is in no small measure related to the shift in risk appetite of market participants, with an increased demand amongst them to secure their credit risk exposures through the taking of high quality collateral,” the paper says. “Official policy makers have also significantly fuelled the demand for high quality collateral as they have advanced steps to make markets more robust, to reduce systemic risk and help mitigate the risks of any future financial crises.”

While this whitepaper is from an EU-based industry group and focuses on the status of collateral in that continent, many of the same forces are at work in American markets. The Dodd-Frank financial reform act significantly increased incentives for collateralizing over-the-counter derivative transactions. This includes instruments commonly used by institutional investors, such as interest-rate swaps. The more collateral parties put up in a transaction, the lower their regulatory burden to the Securities and Exchange Commission.

Equity allocations are rising, and this time it is sustained – despite the prospect of the US Fiscal Cliff – are we entering the “Great Rotation”?

(November, 13, 2012) — The highest level of optimism in financial markets in almost two years has seen investors ploughing assets into equities, despite concern about the US Fiscal Cliff clouding the horizon, a survey has shown.

Over a third of investors responding to the monthly fund manager survey run by Bank of America Merrill Lynch said they believed the world economy would strengthen over the next 12 months. This 34% was the highest level of respondents showing such optimism since February 2011 and marked a 14 percentage point rise over the last month.

For the fifth successive month, investors have increased equity positions while selling off bonds. A net 35% reported being overweight equities, compared to a net 25% last month.

“Momentum has gathered behind the idea that we are on the cusp of a ‘great rotation’ out of bonds and into equities,” said Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch Global Research. “The only missing ingredient is a resolution to the US fiscal cliff.”

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More than half of respondents to the survey thought the potential hit to the US economy was the biggest tail risk. This 54% number was up from 42% thinking the same last month.

However, a sign that investors are moving to a “risk-on” approach could be seen through a greater appetite for emerging markets. A net 37% of respondents were overweight in the sector’s equities this month, up from 32% in October. Investors also indicated they would take overweight Chinese equity positions in the short-term. Figures from Asia’s largest exporter this week showed the country’s output and growth prospects had recovered from a slowdown earlier in the year.

“While sentiment within Europe remains weak, rising allocations to global stocks tell us confidence in general is improving. The jump in China optimism shows how fast sentiment can turn around,” said John Bilton, European investment strategist at Bank of America Merrill Lynch.

Japan remained off the radar for most investors, however. Historic underweight positions were maintained by the panel of respondents and almost 40% predicting the yen will depreciate the most against a basket of major currencies.