March 20 (IFR) - A financial transaction tax (FTT) proposed
by the European Commission could unleash a collateral crunch as
much of the US$639trn over-the-counter derivatives market shifts
to central clearing.
Plans to slap a 0.1% levy on stock and bond transactions and
0.01% on derivatives could raise as much as EUR35bn each year.
But the unintended consequences could pose a problem for
implementation of the swaps clearing mandate that forms the
backbone of the European Markets and Infrastructure Regulation
Repo is set to play an important role in the rising demand
for high-quality collateral by delivering cash in return for
assets that cannot be posted at clearing houses.
"The FTT proposals put at risk the implementation of EMIR,"
said Godfried De Vidts of the International Capital Market
Association (ICMA), an industry lobbying group.
"If the FTT on repo transactions (which facilitate
collateral being available where it is needed) goes ahead, the
regulatory collateral crunch will actually materialise. Is that
what we really want to happen?"
The latest statistics from ICMA show repo activity is
already shrinking due to the LTRO effect. At EUR5.6trn as of
December 2012, outstanding European repo business was 10% down
from a year previously.
And while clearing houses themselves will be exempt from the
tax, investors could incur the charge for simply posting their
collateral at a clearing house.
"It could drastically reduce the mobility of collateral, and
drastically increase transformation costs, making collateral
more inefficient from a mobility perspective. We don't believe
it is the intention of the proposal, but it is one of the
unintended consequences," said Staffan Ahlner, managing
director, global collateral management at BNY Mellon.
"Variation margin is typically required in cash, so you're
asking fund managers to hold vast amounts of cash liquidity to
meet variation margin calls that are determined by factors they
can't control, such as moves in interest rates," he said.
"Without the ability to transform collateral, we are then
looking at a situation where fund managers may have to hold
large parts of their portfolios in cash to meet such margin
Some believe that the importance of transformation may have
been overplayed as a solution to the collateral gap given the
potentially costly nature of the service.
"My guess is that collateral transformation will be fairly
expensive anyway, so it's likely that any increase stemming from
a transaction tax is likely to be small compared to the overall
cost," said Ted Leveroni, executive director, strategy at
post-trade processing firm Omgeo.
"The problem is that there's not that much supply out there.
There might be a lot of US debt outstanding, but the majority of
that is held by the US Fed and sovereign wealth funds - and they
don't want those assets loaned out to a hedge fund unless the
bank provides a guarantee. And that uses up balance sheet for
which the bank has to charge upwards."
Ultimately, the impact depends on the magnitude of a
shortfall. Studies put the additional collateral requirement
associated with derivatives clearing at anything from US$100bn
"No one knows how big the collateral shortfall is, and in
reality it doesn't really matter what the number is as it's not
evenly applied. If you are a government bond fund and the
shortfall is large, you won't be hit too hard, but if you're a
long-only equity shop, even a small shortfall will hurt as it
will fall mostly on you," said Leveroni.
As a Bank of England study highlights, the real figure is
largely dependent on the netting impact.
"The collateral shortfall question is complicated," said
David Little, a director at Calypso, a firm that provides risk
management systems to clearing houses and other market
"The Bank of England estimate was significant for
identifying the importance of netting efficiency to calculate
the final number. The problem is, no one knows what netting
efficiencies will be, and there's a danger there will be a
significant amount of portfolio fragmentation due to multiple
Ultimately, increased collateral demand will be addressed by
a range of solutions including optimisation and a broadening of
acceptable collateral. Eurex is one of the few clearing houses
making the shift to equities, accepting a range of EuroStoxx 50
and DAX stocks as part of its buyside clearing service.
"I expect more CCPs accept equities in a controlled way.
Many are tied to an exchange - if and when LSE acquires
LCH.Clearnet, for instance, accepting highly liquid UK equities
seems sensible," said Little.
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