Banks may need $85 bln under derivatives regs -JPM

NEW YORK, April 29 (Reuters) - Global investment banks would need to raise an additional $85 billion to capitalize new companies if proposals are enacted that require banks to separate derivatives trading from their commercial banking operations, JPMorgan analysts said on Thursday.

U.S. legislative proposals to reform the $450 trillion privately traded derivatives markets would also likely reduce liquidity and shift market share to new entrants such as hedge funds, which are less regulated than banks and which could increase systemic risks, JPMorgan said.

Senator Blanche Lincoln, who chairs the agriculture committee, earlier this month unveiled an aggressive draft bill to regulate derivatives that would require banks to spin off swaps desks if they are protected by federal deposit insurance or access the Federal Reserve discount window.

The bill would also require most swaps to trade on regulated exchanges and pass through clearinghouses. For more, see: [ID:nN16137927]

If rules to require the separation of derivatives businesses were applied globally, most banks would need to raise additional funds to capitalize new investment banking companies with ratings of A, the sixth highest investment grade, or better, said JPMorgan analyst Kian Abouhossein. These ratings would be needed to act as a market making counterparty to derivatives transactions.

In this scenario UBS (UBSN.VX) would be the only global investment bank that already holds adequate capital. Deutsche Bank (DBKGn.DE), by contrast, would have the largest shortfall at $26 billion, JPMorgan said.

French banks BNP Paribas (BNPP.PA) and Societe Generale (SOGN.PA) would also face significant shortfalls of $21.1 billion and $11.8 billion, respectively, the bank said.

U.S. banks Morgan Stanley (MS.N) and Goldman Sachs (GS.N) would need to raise less capital, of $4.5 billion and $500 million, respectively, as they already have higher capital levels relative to their European counterparts, JPMorgan said.

This scenario, in which the banks would need to hold 15 percent in Tier One capital, assumes that rules would be applied on a global basis. If the provision were only introduced in the United States, most participants would likely trade derivatives out of European investment banks.

"The rule would have to be global, otherwise it would have a very material adverse affect on the U.S. banking industry," said Abouhossein.

Rules requiring most contracts to be centrally cleared and traded on electronic platforms could also negatively impede liquidity and shift risks of the contracts to new participants.

"Greater transparency would allow hedge funds that are high frequency traders to come into the space, which would create new players and risks that are not captured by these regulations," said Abouhossein.

Greater disclosure of trade information could also result in smaller trading sizes, as occurred with corporate bonds after the TRACE reporting system was introduced in 2002, JPMorgan said.

"Greater transparency will make it harder to execute large trades, resulting in less liquidity. Volumes will also decline because investment banks will not be able to use their balance sheet as they were able to in the past to accommodate client trades," Abouhossein said.

Liquidity could also be adversely affected by falling demand from companies that use derivatives to hedge business risks if they are required to post higher margins against the trades due to central clearing requirements, he said. (Reporting by Karen Brettell; Editing by Leslie Adler)