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I was told once by a gilt market maker (a GEMM) that the art of market making is to collate as much information as possible in periods of calm, so that when an opportunity presented in periods of dislocation, these could be captured. There weren’t many such periods so the GEMM’s, ducks had to be lined up in readiness, otherwise a significant part of a year’s profit opportunity could be lost. That access to data was one of the privileges of making markets in government bonds. However, if the data is not clean, siloed or lagged it is far less likely to enable clear sighted decisions when opportunities (and risks) arise. One of the reasons hindsight is so attractive to commentators is because once the dust storm of the crisis has settled, the available timelines and salient data become clearer and the real choices become far more obvious. Data surrounding financial resource management, and in particular collateral management is also of increasing importance in managing an investment fund. Recent events, such as the LDI Pension Funds crisis, have thrust collateral management into the limelight. The opportunities to improve on the historic situation of waiting for the counterparty to call for variation margin and retaining sufficient cash to post, has not significantly evolved since the GFC. In fact, in some ways it retrenched to a less flexible system where the asset price decline and the need to sell the same assets to raise cash margin became correlated. As discussed in one of our previous blog posts ( Pension Funds & Collateral Transparency ) the inflexibility of ‘Gold Standard’ CSAs (only permitting Sterling cash to be posted as eligible collateral) may have been a contributing factor in the September Pension Fund debacle. Therefore, finding more flexible ways of calculating and funding collateral portfolios could help to reduce the speed and depth of similar crises in the future. Foremost is avoiding the combination of ‘wrong-way’ risk and a lack of liquidity which ultimately facilitated the negative spiral of the gilts in the PF crisis. As the value of gilts dropped, variation cash margin calls ensued and gilts assets needed to be sold. Further falls in gilts prices led to additional margin requirements and the cycle was repeated. The view that gilts were akin to Sterling cash was destroyed, (No longer worthy of the ‘L’ part of the moniker-HQLA-particularly in the longer dated securities). Selling gilts to raise cash in a stressed market environment led to discounting and fire sales-at exactly the point when Fund Managers may have wished to be buying those assets at depressed prices. The traditional settlement processes (at T+2) meant that when margin calls were made daily, effectively meaning funds were constantly playing catch up while in stressed market conditions. In fact; this issue was further exacerbated by issues at some US custodian banks, where there were hold ups and delays in the agreeing and processing of margin calls. Market dislocations led to significant valuation issues for repo agreements and the collateral haircuts being applied. Nevertheless funds that that had committed repo agreements in place were better able to raise some cash ahead of the T+2 settlement cycle. This still seems a vital tool to reduce the need to sell assets going forwards. Hopefully part of the collateral stress testing includes fund treasurers agreeing such secured financing agreements. This can be using (with suitable collateral haircuts) principal intermediaries such as banks, or, increasingly, agent lenders in the peer to peer space. Committed repo facilities, in particular bring hitherto untapped liquidity to the gilt market. As my market making friend observed, delays in calculation and in agreeing collateral calls due to siloed and incomplete data, add to the fog of a crisis, making it difficult for Treasurers to see the wood for the trees. It is very difficult to act efficiently, let alone optimally when liquidity is drying up so badly, solvency becomes a secondary concern and the opportunity (perhaps to increase positions on advantageous pricing) is lost. For Funds, margin requirements themselves are usually set by the risk manager at the sell side counterparty or the exchange -who complete their internal stress testing models, based off previous periods. Although SIMM has helped standardise margin calculations for large counterparties in uncleared derivatives, however, this is still only a back-testing process. (The short reign of Kwasi and Liz will cast a long shadow over future gilt SIMM margin calculations). Whilst this is a fairly obvious flaw in traditional stress testing, it highlights the impetus for Treasurers to maintain real time data on their fund’s positions to be able to calculate and stress test their own margin requirements, so that their liquidity buffer is sufficient to cope with potential variation margin calls and to capitalise on the prevailing opportunities, but is not inefficient in the amount of liquidity put aside.  In regard to combatting these issues, it is important to build a collateral portfolio. Although there is not one sole method, the 3 key specifications were thought to be: high credit quality securities, high liquidity, and high diversification. This usually entailed high quality, shortest-dated securities. In fact; the Kwasi crisis has shown that ‘high quality assets’ does not necessarily equate to ‘liquidity’ and in some cases of high volatility main index equities may provide more liquidity than bonds. (Although an important caveat is that Archegos illustrated the danger of concentration risk in equities). The overarching theme here is the ability to have enough information to be agile. Having effective digital financial resource management tools at your disposal could be invaluable. Siman Systems offer digital treasury software designed to increase transparency. In short, a closer to real time view of the liquidity health of the organisation and less reliance on custodians and counterparties, enabling investment funds to allocate resources not only to save costs, but also to be able to in a position to make significant gains on the bottom line.