Central bankers around the world are working hard to deploy extraordinary monetary policies to bolster flagging economies. Alongside this, they are introducing important new financial stability reforms aimed at reducing the likelihood and effects of another major financial crisis. These expanded mandates, however, are often accompanied by limited resources and tight implementation deadlines. As a result, central bankers have sought out trusted intermediaries to help them fulfil their objectives.
One institution that has emerged as an increasingly valuable strategic partner is BlackRock Solutions.
Part of New York-based BlackRock, with its $4.72 trillion in assets under management, BlackRock Solutions opened its doors to external parties in the 1990s, first to GE Capital and then to Freddie Mac. It has three main businesses: 'Aladdin', which includes risk analytics, an investment platform, investment accounting and operations outsourcing; 'client solutions', comprising strategic and tactical asset allocation, risk budgeting and portfolio optimisation, and education; and 'financial markets advisory' (FMA), with a focus on valuations and risk assessment, financial/balance sheet strategy, bespoke modelling and analytics and disposition of distressed assets.
BlackRock Solutions' coverage means it can act as a strategic partner to central banks whether they are seeking help in introducing complex asset purchase programmes, conducting asset quality reviews, implementing resolution mechanisms or repurposing strategic asset allocation frameworks for their reserves or pension funds. The US firm is particularly strong in mapping out large numbers of different assets across multiple markets, including complex and illiquid instruments that require large amounts of modelling and processing power. It draws on vast amounts of data to adopt a 'bottom-up' approach to its work to complement 'top down' assessments.
This was one of the reasons the European Central Bank (ECB) commissioned the firm to lead its investigation into the viability and efficiency of creating an asset-backed securities (ABS) purchasing programme in 2014. The purchase of ABSs and covered bonds by the Eurosystem was aimed at complementing its targeted longer-term refinancing operations, and was the pre-cursor to the current €60 billion a month quantitative easing programme that ultimately involved the purchase of government bonds. At the time, there was a lot of scepticism about the validity of an ABS programme, as many of the securities on offer were located in economies such as Germany and the Netherlands, rather than the troubled economies of southern Europe.
BlackRock Solutions helped the ECB to size and understand the idiosyncrasies of ABS markets in the eurozone. Its analytical tools also enabled the ECB to monitor how these assets would be acquired as well as helping the ECB to monitor its positions held via external managers. This ensured the pool of assets purchased behaved as expected and were acquired at appropriate prices. While small in scale compared with its sovereign and covered bond activities, ABS purchases were an important component in the ECB's quantitative easing programme.
While BlackRock has dedicated teams working across a range of European ABSs, it cut its teeth in the US mortgage-backed securities (MBS) market. This is where the firm first started processing large data pools, using detailed models and analysing assets at the granular level. Early work was with Freddie Mac. But as the financial crisis hit, it was engaged by the Federal Reserve Bank of New York to value Bear Stearns' assets including MBS used as collateral to support a near-$30 billion LCC funded by the New York Fed and JP Morgan in conjunction with JP Morgan's bid to buy Bear Stearns. It subsequently earned a reputation in asset valuation, and risk and asset management with US government entities.
More recently, BlackRock offers pre-payment modelling and market risk analysis via its Aladdin risk platform to a large official institution in relation to its agency MBS portfolio. The firm projects base-case prepayment spreads and expected cashflows for the entire portfolio, and offers a range of scenario analytics to assess how different macroeconomic changes could affect the value of the portfolio and expected cashflows – an area that has emerged as a 'sweet spot' for the firm. "They are timely and accurate and always a pleasure to work with," says a senior official at the official institution.
The Aladdin risk analytics engine currently processes $17 trillion of assets on behalf of 190 clients, including $2.5 trillion of assets of central banks and other official institutions. Notably, in 2015, BlackRock added Fannie Mae to its risk and trading operations platform, Aladdin, in addition to Freddie Mac. Both mortgage agencies have used Aladdin for analytical purposes for retained asset portfolios for some time. This ensures they get a daily balance and risk sensitivities of their holdings, expressed in 'greeks'. They can also run scenario analyses on their portfolios to measure the impact of extension risk due to less mortgage refinancing if the Federal Open Market Committee raised interest rates.
The more recently added operational capabilities include settling securities, helping the agencies determine the amount of debt they need to issue to fund their portfolios and support their derivative hedging requirements.
Asset allocation advice
BlackRock has also acted as an adviser to help central banks develop new strategic asset allocation (SAA) frameworks for their reserves portfolios, based on their yield and liquidity requirements, according to Terrence Keeley, BlackRock's head of official institutions. In essence, this involved studying the implications of adding higher-yielding assets to existing strategic benchmarks using the Aladdin platform.
The Bank of Israel was one central bank that has turned to BlackRock Solutions for SAA advice across its entire portfolio, looking specifically at 5-year and 10-year views. Golan Benita, head of strategic management at Bank of Israel, says the Israeli central bank enjoys a "long and good relationship" with BlackRock and values its "expertise" and "wide knowledge" in the field of portfolio selection and asset allocation.
Benita adds that he believes BlackRock's confidentiality arrangements are sufficient to ensure the Israeli central bank is comfortably sharing its portfolio data with BlackRock, which carried out SAAs for the Israeli central bank in 2013, 2014 and 2015. Benita praised "the quality of the analysis" and "the commitment to provide a tailor-made solution for our goals and constraints".
"We do SAA based on our view and tools, but we use BR's advisory as an important input in the SAA decisions," Benita says. It was a similar story at other official institutions.
Asset quality assessment
BlackRock Solutions has also helped central banks, particularly European national central banks (NCBs) such as the Bank of Greece, Banque de France, the Central Bank of Ireland and the Netherlands Bank, in their work in the areas of banking regulation, resolution and lender of last resort activities.
It has forged a particularly close relationship with the Dutch central bank, notably as 'execution lead' for the ECB-orchestrated asset quality review (AQR) for seven Dutch banks with combined assets of €1.3 trillion. The AQR work required reviewing more than 50 domestic and international portfolios, following a prescribed methodology set out by the ECB.
The Netherlands Bank engaged BlackRock Solutions to start portfolio selection in January 2014, and the US firm brought in a team in excess of 25 staff to assist with AQR work later that year. The results of the AQR formed the basis of a subsequent stress testing exercise conducted by the DNB in conjunction with the European Banking Authority.
In addition to reviewing traditional bank loan portfolios, BlackRock Solutions also had to appraise many illiquid portfolios, including those containing derivatives and private equity, often in securitised form. "Specifically given the size of the Dutch mortgage asset class, we also did a lot of model validation and review evaluation of a lot of the mortgage pools within some of the largest Dutch banks," says Jerome Finkel, a director at BlackRock Solutions in London
The AQR manual produced by the Single Supervisory Mechanism within the ECB ran to about 300 pages, and was subsequently amended and completed through a comprehensive Q&A process containing approximately 2,000 questions as well as 40 circulars. Given the speed at which the framework was established, some of the initial answers contradicted the manual. Supervisors also made a lot of the assumptions, some of which given the timeframe were broad in some areas, and it is understood BlackRock helped the DNB make refinements to the rules, specifically on mortgages.
"BlackRock was selected as a very important partner to support DNB in this project," says Vivian van Ravenswaay Claasen, the Netherlands Bank's project manager on the AQR. "BlackRock provided invaluable support based on their previous experience in this field."
The Central Banking awards were written by Christopher Jeffery, Tristan Carlyle, Daniel Hinge, Arvid Ahlund, Dan Hardie and Rachael King.