Reuters: Regulatory News: Banks move to plug $2 trillion trading gap

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Banks move to plug $2 trillion trading gap Mar 29th 2012, 11:43 By Luke Jeffs LONDON, March 29 | Thu Mar 29, 2012 7:43am EDT LONDON, March 29 (Reuters) - A select group of banks are hoping to cash in on new regulations by helping their clients find $2 trillion in guarantees they will need to carry on trading complex debt instruments. Interest rate swaps - in which financial firms like asset managers or investment banks effectively swap one set of cash flows for another - are largely traded over the phone, a practice that has made these deals virtually invisible to regulators. From next year, such swaps and other derivative instruments - often worth hundreds of millions of dollars - will have to be chanelled through clearing houses, which guarantee pay-outs in case any of the counterparties goes under. The clearing houses in turn will require counterparties - investment banks, hedge funds and asset managers - to put up collateral so as not to expose themselves to heavy losses. The U.S. national bank regulator has said the regulatory changes could increase the value of collateral by $2 trillion, an increase of 50 percent on current levels. To help them find the extra money, the world's top collateral banks, such as JP Morgan, Northern Trust and State Street, are investing hundreds of millions of dollars in their services. "Clearing has become a top priority for us ... and the biggest impact from the changes in clearing will be felt within collateral management," said John Southgate, who works in Northern Trust's collateral management unit. A Morgan Stanley and Oliver Wyman report released last week said the revenue opportunity for custody banks and settlement houses, which provide access to collateral through stock lending or repo markets, co u ld be as high as $2 billion. BANKS MOVING IN Euroclear, the European securities warehouse that settles trades on behalf of its clients by moving stock and cash between counterparties, struck this month a landmark deal with BNP Paribas. Under the terms of the agreement, trading firms that are clients of both BNP Paribas Securities Services and Euroclear can use the assets they have deposited with BNP to underwrite transactions with Euroclear. "This type of partnership ... will offer even greater optimisation of collateral to our mutual clients," said Alain Pochet, head of clearing, settlement and custody at BNP Paribas Securities Services. Euroclear was keen to stress the arrangement was not exclusive and it was open to other custodians: "This agreement effectively opens up a huge new source of collateral for funding purposes by offering clients an easy way to access larger collateral pools," Olivier de Schaetzen, director of collateral services at Euroclear, told Reuters. Separately, Northern Trust is collaborating with rivals to streamline how the banks exchange crucial collateral information with clients. And clearing house LCH.Clearnet is working with its banking clients to help them make best use of collateral and provide them with access to new sources of assets. "We believe that collateral management could become a big differentiator for clearing houses," said Andrew Howat, head of collateral and liquidity management at LCH.Clearnet. MOVING TARGETS One issue that custodians are going to help clients solve is sorting out the types of assets they can use as collateral. Currently these include cash, blue chip equities and highly rated government bonds. "The onus is on us to take a wider spectrum of assets, bearing in mind that we need to be able to liquidate those assets promptly in the case of a default," said Howat. That clearing houses are now continually changing the types of assets they are prepared to take presents another challenge for clients that their banks are keen to address. "The eligibility of securities varies from clearing house to clearing house however and the haircuts applied are continually changing so we have to monitor these changes for clients," said Southgate. Currently, collateral contributions are manageable partly because most of the instruments cleared - mainly stock and futures - take only a few days to settle so the period one firm is exposed to another is relatively short. Furthermore, the relatively low value of individual trades - as little as a few thousands dollars for the most liquid shares - means the money trading firms need to put up is within reach. But firms' margin commitments are set to increase dramatically after Dodd-Frank legislation in the United States and European Market Infrastructure Regulation (EMIR) in Europe force OTC products to be cleared, likely next year. The increase is related to the fact OTC derivatives have a longer lifecycle than most current cleared products, measured in years or decades rather than days, which increases the possibility of a counterparty defaulting and the margin needed. Similarly, the value of some OTC swap trades can run into hundreds of millions, further hiking the margin that will be required by an estimated $2 trillion. Link this Share this Digg this Email Reprints

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