A survey of financial market participants most likely to be negatively affected by new regulations on uncleared swap trades revealed that they don’t like this new-fangled way of doing things at all. No, no, they really don’t.
The completely predictable result was published in an article in Risk on Wednesday:
Sixty per cent of respondents to a survey thought end-users will opt not to use derivatives as a result of proposals published in July… If those rules come into force, derivatives participants will be required to post initial and variation margin on uncleared swap trades – a development that could lock down several trillion dollars in collateral.
The whole margin-on-uncleared-swaps thing started when the US got ahead of the rest of the world when it came to regulating the bejesus out of their financial sector.
Part of the initial push was making sure that swaps, that weren’t mandated to enter clearing, would have decent margin requirements — something that isn’t typically done in over-the-counter markets at the moment. Or at least, when it is done, it usually involves a polite discussion with one’s counterparty over tea and biscuits.
With those regulations only applying to US banks, it was perhaps inevitable that said banks would shout and scream until an international working group was formed to come up with rules that could be applied across the globe.
Once it was duly established that everyone was going to have to deal with posting margin on uncleared swaps, something beautiful happened — now they could all get upset together, this time about the amount of collateral the new rules would demand. From another Risk article:
In April last year, the Office of the Comptroller of the Currency published an impact study on the US margin proposals for uncleared trades, which estimated approximately $2 trillion would be locked away in third-party custodial accounts in the first year after the new rules had been implemented.
Cue industry lobby group Isda to say how sucky this is:
These kinds of numbers have industry participants worried. “If you take the liquid assets that are required by Basel III’s liquidity coverage ratio, central counterparties and potentially strict initial margin requirements on uncleared trades, there is no doubt that all these rules taken together will cause a collateral shock. The competing demands will inevitably cause collateral to become an increasingly scarce and expensive commodity,” says Peter Sime, head of risk and research at the International Swaps and Derivatives Association in London.
The thing that gets us about the Risk poll (other than not knowing the sample size) is that we’re not sure who the 60 per cent were referring to with “end-users” that “will opt not to use derivatives as a result of proposals”. Here’s an extract from the proposals:
There was broad consensus within the BCBS and IOSCO that the margin requirements need not apply to non-centrally-cleared derivatives to which non-financial entities that are not systemically-important are a party, given that (i) such transactions are viewed as posing little or no systemic risk and (ii) such transactions are exempt from central clearing mandates under most national regimes.
So, non-financial entities are exempt provided they aren’t deemed to be “systemically-important”. In other words, most corporates, which are a relatively small part swaps markets anyway, are exempt.
We assume, therefore, that the concern is around financial institutions that are clients rather than dealers. A cynic would point out that even that segment is a small part of most derivatives markets. Such end-users do, however, give rise to enormous amounts of trading which we’re certain (wink) is all about hedging (wink).
On top of that, we are talking about uncleared swaps here, right? As in, they aren’t liquid and/or standard enough for clearing? Why shouldn’t those be margined properly?
Banks don’t appreciate being told how to handle their counterparty risk management any more than parents like being told how to raise their children. And of course, the collateral crunch is very real. But frankly, the 60 per cent — if they didn’t just respond that way as a protest vote — are just going to have to get with the programme.
End-users will stop using derivatives – Risk
WGMR margin rules borrow heavily from US proposals – Risk