February 22, 2013 / 11:51 AM / in 5 years

UPDATE 1-Societe Generale planning CVA securitisation - sources

* Deal backed by bank counterparty derivatives exposures

* Basel III raises hurdles on banks shedding risk via ABS (Adds background, quotes)

By Christopher Whittall

LONDON, Feb 22 (IFR) - Societe Generale is close to securitising a portfolio of derivatives counterparty risk in order to relieve some of the punitive capital treatment these exposures attract under Basel III, sources with knowledge of the situation have told IFR.

It comes as a number of banks are understood to be lining up transactions to reduce the capital held against credit valuation adjustments (CVA) on derivatives exposures in order to shed RWA, boost capital ratios and make trading businesses more efficient.

Societe Generale declined to comment. There have been a handful of other deals since the financial crisis including a privately placed structure from UBS and one from Credit Suisse’s 2011 compensation scheme. Elsewhere, Deutsche Bank de-recognised a first-loss tranche on a portfolio of counterparty risk according to its 2011 Pillar 3 report. RBS was also said to be working on a structure last year.

Last year, Credit Suisse gave employees structured notes referencing derivatives counterparty risk as part of their annual bonus. The USD8bn CVA synthetic securitisation represented 18% of the bank’s credit exposure in its derivatives portfolio.

Banks say the regulatory scrutiny on such deals is intense, and many are expected to wait until the rules are finalised when CRD IV is released later this year.

“The regulation is not clear yet, and these deals attract a huge amount of internal and external attention,” said one head of credit at a US bank.

“You need a big motivation to finalise one of these deals, but people will find a way to do it.”

The latest regulatory guidelines indicated that tranched structures would not receive capital relief under Basel III, making it harder for banks to offload this risk to investors.


This means the bank would have to buy protection on the entire portfolio rather than just a first loss tranche. As a result, the onus on the investor in such deals - most likely sophisticated hedge funds - is potentially very high as they would have to sell billions of dollars worth of protection.

BlueMountain Capital and Renshaw Bay are just two funds that are understood to be developing capital-efficient structures that would enable them to invest in these deals.

Financial counterparties are the main underlying risk in the portfolios. Even though derivatives between banks should be fully collateralised, the potential jump-to-default risk of these exposures is the main driver of the Value-at-Risk on banks’ CVA portfolios.

There are other complications with structuring CVA securitisations as well as the capital needed to invest in a non-tranched structure. Confidentiality laws mean the investor will not know the underlying pool of names in the portfolio (although they will have a broad idea that they’re investing in BBB rated banks, for instance).

Due to the dynamic nature of banks’ derivatives portfolios, banks will also want the option to substitute names in and out. Lastly, derivatives exposures tend to be long-dated, so the investor is potentially committing capital to the transaction for many years to come.

As a result, investor demand high returns - between 10% and 15%, according to people with knowledge of these deals.

“CVA deals are complicated and structuring them well is a vexing problem. But there are a lot of assets out there and banks will be incentivised to make this work because of the regulatory capital attached to these exposures,” said one investor. (Reporting By Christopher Whittall, editing by Alex Chambers, Anil Mayre)

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