Jun 18, 2014
• White Papers
LSE Study: The Economics of Collateral
An academic study into the current and projected collateral supply and demand as well as challenges facing the industry by Ronald Anderson and Karin Jõeveer of the London School of Economics and Political Science
This academic study analyses how the use of collateral is evolving under the influence of regulatory reform and changing market structure. It consists of two parts: an in-depth literary review and a modelling exercise, where theoretical alterations are made to dominant model for OTC derivatives trading. With the onset of the financial crisis in 2007-2008 market participants sought safety by demanding more and better collateral to support their transactions. This change in behaviour has been reinforced by changes in regulation (e.g. Basel 3) and by structural initiatives to increase the use of centralized trading platforms and CCPs. This has given rise to an interest in the prospect of a scarcity of collateral that might inhibit economic growth. There have been various attempts to estimate the extent of this scarcity, but little agreement on the numbers.
The authors of this study argue that it is unlikely that there is an overall shortage of collateral. It is, however, possible that there may be bottlenecks within the system due to weaknesses in infrastructure which mean that the available collateral is immobilized in one part of the system and unattainable by credit-worthy borrowers. These bottlenecks are identified in the literary review as issues relating to central bank policy, willingness of investors to make assets available for re-use, contractual and regulatory restrictions on re-use, and CCP risk management techniques. In the modelling exercise they are identified as issues relating to market depth, inter-bank market liquidity, intra-regional market liquidity and level of CCP specialisation. The authors state that problems relating to collateral access can be overcome by improved information systems and collateral transformation.