RPT-Fitch: Lack of Collateral Poses Added Risk for SF & Covered Bond Cross-Currency Swaps
Sept 18 (Reuters) - (The following statement was released by the rating agency)
Providing collateral with significant cushion remains an important remedy to counterparty ineligibility in a structured finance and covered bond cross-currency swap, according to Fitch Ratings in a new report. Only allowing replacement as a remedy with little or no collateral posting beforehand exposes noteholders to extra risks, Fitch adds.
"Without collateral providing ample support, both structured finance and covered bond issuers can accumulate significant exposure to cross-currency swap counterparties that may exceed the level of credit protection available to even the most senior notes," said Grant England, Senior Director in Fitch's Structured Finance team. "An unmitigated default of the counterparty can lead to losses being allocated to all noteholders."
Fitch believes that a combination of documented collateral posting and replacement obligations is the most effective way to mitigate the large counterparty exposures that can arise in cross-currency swaps. Fitch has observed proposals that focus on earlier replacement obligations, with lower or no collateral posting commitments before replacement. These proposals do not adhere to Fitch's rating criteria. In practice, downgraded counterparties invariably elect to post collateral in the first instance, given that replacement can take significant time.
By excluding options to post collateral, the issuer becomes exposed to a 'jump-to-default' risk. This is when it is impossible to replace the swap on a timely basis and either no or limited collateral has been posted in the interim.
Such limited timeframes and options also constrain the ability of counterparties to novate swaps in an orderly fashion. In turn, this increases the likelihood of future documentation changes from counterparties who, contrary to upfront documentation, seek to post collateral post-downgrade.
Moves for reduced upfront documented collateral posting obligations are largely motivated by increased liquidity costs. Regulations like Basel III call for liquidity to be held by counterparties with respect to documented collateral obligations that are contingent upon the breach of rating thresholds.
Fitch says it has also received comment from some market participants that its 'volatility cushions' for cross-currency swaps are high in comparison with some other rating agencies' criteria. Volatility cushions allow for added collateral to be posted beyond marking a position to market to stem potential movements in the swap value during the time required to secure a replacement counterparty.
While the appropriate size of volatility cushions is subjective, small volatility cushions offer very limited protection to issuers and noteholders.
This is especially true under potentially prolonged replacement timing assumptions. Fitch's report presents analysis illustrating the adequacy of different levels of volatility cushion under different replacement timing assumptions.
The report also includes insights from a case study of a Lehman-originated UK RMBS Eurosail transaction that suffered from the default of Lehman as the currency swap counterparty, which helps illustrate some of the risks involved.
Fitch explains the issues in greater detail in its special report 'Collateral in Cross Currency Swaps: Important Mitigant of Counterparty Risk', available at www.fitchratings.com or by clicking on the link below.
Link to Fitch Ratings' Report: Collateral in Cross-Currency Swaps: Important Mitigant of Counterparty Risk
- White House reverses, says Obama met uncle and lived with him during law school
- Flights delayed as air pollution hits record in Shanghai
- South Africa mourns Mandela, will bury him on December 15 |
- RPT-UPDATE 1-Ford leans on global Mustang to burnish overseas image
- Analysis: Boeing bidders dangle goodies to win 777X jetliner