(This story previously appeared in International Financing Review, a Thomson Reuters publication)
By John Geddie and Christopher Whittall
LONDON, Oct 8 (IFR) - As the world’s largest public issuers gather behind closed doors at the IMF/World Bank Annual Meeting this week, a once arcane topic will now figure at the top of the agenda: posting collateral to swap counterparties.
Bankers would pay good money to be flies on the wall for this conversation. They have persistently badgered their most important clients since the onset of the financial crisis to abandon their treasured one-way credit support annexes (CSAs) - contracts that require banks to post collateral to sovereign, supranational and agency (SSA) issuers when out of the money on swaps, while not receiving collateral when the situation is reversed.
Many of the largest SSAs have refused to budge, with the prospect of millions in collateral flying out of the door proving a strong disincentive. But after having inched up swaps prices over the past year to compensate for these asymmetric contracts, dealers are at last signalling a turning point.
“All clients are aware of this issue and there is a real movement in the direction of more and more issuers signing two-way CSAs,” said the SSA head at a US bank. “Some are still in denial and refuse to go down that route, but the number in that camp is quickly becoming the minority.”
One-way CSAs are a hangover from the pre-crisis era of SSAs using their superior credit quality to demand collateral from banks without having to reciprocate. These exposures have become prohibitively expensive for banks under Basel III, which requires funding and credit costs to be priced appropriately. This can add tens of basis points on to quotes for the long-dated interest rate and cross-currency swaps that SSAs use to manage their liabilities.
Banks have been urging SSA clients to sign two-way CSAs over the past few years with mixed success. Some, such as KfW and the Bank of England, volunteered to post their own bonds as collateral; others, including the debt offices of Portugal and Ireland, capitulated upon facing market lock-out.
But dealers are at last reporting considerable progress as clients come round to the merits of adjusting their collateral agreements to secure better swaps pricing.
“Issuers have woken up and smelt the coffee. They see the size of the costs banks are passing on - which can be very meaningful in terms of basis points - and realise this isn’t going away,” said the head of DCM at a European bank. “Clients are looking at something that is palatable for them that will allow banks to reduce their charges.”
One such example is BNG. The Dutch public agency switched to two-way CSAs a couple of years ago and banks say the entity is now lowering the threshold level at which it would post collateral in an effort to mitigate costs.
“In the past we had different agreements depending on the counterparty, but now we have two-way CSAs across the board,” said Bart van Dooren, head of funding and investor relations at BNG, declining to comment on individual contracts. “Now, if we start negotiations with a new swap counterparty, with which we don’t have a collateral agreement, then we immediately start discussions with two-way CSAs.”
Austrian export credit agency OeKB was in discussions with counterparties on two-way CSAs, but was prompted to implement these across the board after Standard & Poor’s downgraded Austria’s credit rating in January this year.
While there are rumours that some of the supranationals may be warming to the idea, at present only the Nordic Investment Bank has two-way CSAs in place, and even then the threshold is so high that it has only been activated on a handful of occasions over the past five years.
Unfortunately for dealers, the issuers with the biggest swaps programmes - the European Investment Bank and the World Bank - are stubbornly refusing to sign two-way CSAs.
Bankers bemoan this foot-dragging, claiming it attaches a stigma to two-way CSAs and discourages smaller SSAs from moving. Dealers are fast running out of patience with these issuers, while many deliberately bid uncompetitive swaps prices.
“It is about cost, access and concentration risk. These three things will bring the issue to a head in the next six to 12 months,” said one SSA banker. “At this stage all these larger issuers will get to limits with their counterparties, and then the banks will have the issuer between a rock and a hard place and will be able to increase their charges.” (Reporting By Christopher Whittall and John Geddie, Editing by Helen Bartholomew)