Asset segregation as proposed under the alternative investment fund managers’ directive (AIFMD) will compromise tri-party collateral management and securities lending, according to Ross Whitehill, managing director of BNY Mellon Markets Group.
A recent ESMA consultation paper proposed the enforced segregation of alternative investment fund (AIF) assets across all levels of the custody chain. This could affect the ability of funds to utilise tri-party collateral management services, and to participate effectively in securities lending.
The change also has the potential to affect UCITS funds, depending on regulatory harmonisation with AIFMD.
Whitehill said: “The impact on funding and liquidity in the market will, we believe, be very significant affecting growth and investment in Europe.”
The proposed asset segregation rules are intended to protect the interests of investors by preventing assets from being exposed to negative events, such as bankruptcy of a third party.
Whitehill argues, however, that taking this too far by segregating assets down to sub-custodian level could in fact increase, rather than mitigate, counterparty, operational and systemic risk.
“The proposed segregation approach actually increases investor risk along the post trade chain,” he said.
“It also increases systemic risk. This is due to the substantial increase in accounts, a corresponding increase in movements of securities, and in particular the inability of AIFs to function in a tri-party environment.”
“There will also be increased settlement and operations risk because market deliveries will be necessary, rather than intraday book entry books and records management.”
He also suggested that there would be an impact on pension funds, insurance companies and other non-AIF counterparties, as there will be no third-party collateral managers available to support related transactions such as repo and securities lending.
Whitehall said: “Collateral management is a highly specialist function and – given the demand for, and likely scarcity of eligible collateral – it is highly unlikely that funds will be in a position to effectively support their collateral management requirements themselves.”
“The removal of tri-party collateral management will place an inordinate burden on the funds themselves and their counterparties, forcing them into bilateral collateral management.”
