JPMorgan is the first bank to accept gold bullion as collateral via its tri-party collateral management arm. In a press release yesterday, the bank said it was responding to client needs as many of them held gold and wanted to “make these assets work for them as collateral.” Is this the first commodity to be used in such a way given that government bonds, cash and equities are the norm for securities financing?
This does seem to be a logical step given that gold is such a popular investment, but why now? Let us not forget that prior to the last few years, gold was generally unloved apart from times of great dislocation. As such, capital markets have not spent much time trying to make gold as flexible as equities, bonds or cash.
JPMorgan is breathing some life into a hitherto “dead” asset that just sat in a vault. This must reflect a view that investment in commodities is here to stay. For example, the most popular gold ETF owns USD 77.6bn of gold bullion and this would place it in the top decile of companies in the S&P500 by market cap and it is just one of many gold ETFs.
Gold is already taken as a form of collateral for retail investors at places like the Chicago Board of Options Exchange where a haircut (excess) of 15% is required. One wonders if a similar margin will be required when professional investors use it in JPMorgan’s tri-party facility, given that haircuts for bonds and cash would be more like a 5% positive margin.
Other classic collateral duties remain the same with a daily mark to market taking place to ensure that the gold collateral meets the guideline haircut required by whoever’s shares are on loan. Rumor has it that a van drives around London each day moving gold to whichever of the seven vaults require it. This van may be about to do a lot more trips!
This brings me to another key point which is that gold is one of the few commodities that lends itself to being used in this way. The entire USD 77bn of physical gold owned by the GLD ETF would comfortably fit into a normal sized hotel room. JPMorgan intend to offer the facility to process other forms of commodity based collateral in its tri-party service, but how many other commodities are non perishable, small, and unmanageable? The other point making this so easy for JPMorgan is that it is already a major player in the physical storage of gold.
Many banks have gold reserves that they will be happy to post as collateral to raise cash, but will this help Hedge Funds in any way? This seems unlikely since not many funds, other than Armajaro which owns lots of cocoa, hold physical commodities directly. Also, how many of the classic lenders of securities, the Mutual Funds, are ready to add gold to their list of approved collateral?
Finally, it is interesting that gold has beaten ETFs as a form of acceptable collateral. What will be next?
