Cross-Border Collateral

Cross-border collateral is collateral with a foreign element. The asset may be held in a central securities depository in another country, issued under foreign law, or denominated in a currency other than that of the credit it secures. A typical example is a bank pledging its holdings of another country's government bonds to its home central bank to obtain intraday credit in a domestic payment system. Global banks, central counterparties and central banks all deal with cross-border collateral.

The appeal is efficiency: large banks hold securities in many markets and want to use them wherever they need liquidity, instead of keeping a separate stock of local assets in each one. The drawbacks are legal, operational and market risks that do not arise with domestic collateral. International bodies such as the Committee on Payments and Market Infrastructures have studied how central banks can accept foreign collateral safely, especially to support liquidity in stress.

Someone living in London wants a loan from a local bank and offers their holiday flat in Spain as security. The flat is valuable, but the bank has to deal with Spanish property law, a different land registry and possibly a sale in another currency if the loan goes bad. It may still accept the flat, but it will want a bigger safety margin and clear legal advice.

Cross-border collateral works the same way for banks. A bank can pledge assets held abroad to borrow at home, as long as the lender is confident it can legally take and sell them quickly if things go wrong.

There are three common routes for moving collateral across borders:

• Correspondent central banking. The home central bank asks the central bank in the country where the asset is held to act as its custodian. The Eurosystem's correspondent central banking model, introduced in 1999 with the euro, worked this way for marketable assets held in other euro area countries.
• Links between securities settlement systems. A CSD in one country holds an account in a CSD in another, so assets can be moved to the home system and pledged there.
• Custodians and tri-party agents. Global custodians and international CSDs hold assets across many markets and can allocate them to secured lenders through a collateral management service.

Central banks decide whether to accept foreign collateral in their monetary policy and payment system operations. Some accept only domestic assets. Others accept certain foreign government bonds, usually with extra haircuts and concentration limits. Accepting cross-border collateral can help in a crisis, when banks may have assets abroad but a sudden need for local currency. It works alongside other tools such as central bank swap lines, which provide foreign currency to central banks rather than directly to commercial banks.

Cross-border collateral adds several layers of risk:

• Legal risk. The lender must be sure its security interest is valid under the law that governs the asset and the account, and that it can enforce quickly if the borrower fails.
• Currency risk. If the collateral is in a different currency, its value can fall relative to the exposure through foreign exchange risk, so lenders add a currency haircut.
• Operational and time-zone risk. Moving assets through several custodians and systems in different time zones can delay mobilisation just when speed matters.
• Sovereign and transfer risk. Capital controls or political events in the issuing country could block the transfer or sale of the asset, a form of sovereign risk.
• Custody risk. Assets held through chains of intermediaries expose the lender to custody risk at each level.

For a global bank, the ability to use cross-border collateral shapes how it manages liquidity risk across its branches. For CCPs, it affects which securities they accept as initial margin from foreign members. The Principles for Financial Market Infrastructures ask FMIs that accept cross-border collateral to identify and manage the associated risks and to make sure the collateral can be used in a timely manner. As settlement becomes faster and more automated, the speed at which collateral can be moved across borders matters as much as its quality.

• Committee on Payments and Market Infrastructures (CPMI)