Reuters: Regulatory News: Uncleared swap margin rules now just months away

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Uncleared swap margin rules now just months away Sep 27th 2012, 19:26 By Mike Kentz Thu Sep 27, 2012 3:26pm EDT NEW YORK, Sept 27 (IFR) - The Basel Committee on Banking Supervision and IOSCO are less than three months away from submitting final rules for margin requirements on uncleared swaps, a framework estimated to cost an additional US$2trn in collateral for the derivatives market. Banks say the current proposals are too onerous, specifically because they require "universal two-way margining," which means that systemically important counterparties must both post enough initial and variation margin to ensure full compensation to their counterparty in the case of default. While a vast majority of OTC swaps are expected to migrate into the relatively safe hands of a new clearing framework, the banking industry maintains there is a need for a bilateral, uncleared market where dealers can create bespoke swaps for customers that address their specific portfolio needs. The BCBS-IOSCO proposals run the risk of making that market obsolete, they say. The fear outside of the industry is that dealers are only making that claim so they can create complex, unclearable swaps in order to avoid the high costs of clearing. Additionally, regulators feel the bilateral market is rife with risk, since there is no regulated exchange or clearinghouse to house the transaction. As a result, regulators are hoping to create protective barriers around the uncleared market so that any transaction, no matter how complex it may be, will be backstopped by enough margin to ensure an overall reduction in systemic risk as well as incentivise the use of cleared derivatives. After Friday, the decision regarding how much margin will be enough to accomplish that goal will no longer be part of a democratic process. A consultative period that began in July will close Sept. 28, with the regulatory working group planning to publish final rules in December. The group will also conduct a quantitative impact study to assess the rules' affect on liquidity, though a spokesperson said there is no guarantee the results will be published. BCBS-IOSCO does not publish industry comments until after the consultation period closes, but conversations with dealers provides plenty of evidence that the current proposals are viewed as less than favourable. "My sense is that proposals would result in the immobilization of a very large amount of available liquidity which is completely out of proportion to the gap risk they are seeking to mitigate," said one major bank's point person for regulatory discussions. "It's unfortunately just one of several impractical and misguided aspects of the proposal." The BCBS-IOSCO paper most notably submits that all uncleared derivatives should be regulated, systemically important firms should be required to post initial and variation margin under a universal two-way margin framework, the netting of risks across asset classes within a swaps portfolio should not be allowed, and that rehypothecation of a counterparties' collateral for use in other transactions should be prohibited. "These non-centrally-cleared derivativeswill pose the same type of systemic contagion and spillover risks that materialised in the recent financial crisis," reads the BCBS-IOSCO proposal. "Margin requirements for non-centrally-cleared derivatives would be expected to reduce contagion and spillover effects by ensuring that collateral are available to offset losses caused by the default of a derivatives counterparty." NETTING ACROSS ASSET CLASSES The banking industry believes there is opportunity for compromise on the issue of netting across asset classes. The BCBS-IOSCO proposal acknowledges that derivative portfolios often contain exposures that can be net down against one another, but proposes to prohibit cross-asset netting on the basis that "inter-relationships between derivatives in distinct asset classes, such as equities and commodities, are difficult to model and validateare prone to instability and may be more likely to break down in a period of financial stress." Bankers disagree, saying that certain portfolio combinations can be efficiently netted down, such as a long position in a stock and a short credit position in the same underlying company. "All we are asking for is that the regulators consider our models for cross-asset netting in certain scenarios," explained Robert Lee, director in systemic risk management at Deutsche Bank in New York. "As part of our model development process, we would develop the models to demonstrate correlation across asset classes and submit them for approval. If they say no [at that point], fine, but to say that correlation cannot be established across asset classes at all is too broad of a generalization." For other related fixed-income quotations, stories and guides to Reuters pages, please double click on the symbol: U.S. corporate bond price quotations... U.S. credit default swap column........ U.S. credit default swap news.......... European corporate bond market report.. European corporate bond market report.. Credit default swap guide.............. Fixed income guide...... U.S. swap spreads report............... U.S. Treasury market report............ U.S. Treasury outlook... U.S. municipal bond market report...... Link this Share this Digg this Email Reprints

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