ATP, Denmark’s biggest pension fund, said it renegotiated contracts to avoid having to accept top-rated French sovereign bonds as collateral for funding.
The 711 billion-kroner ($122 billion) fund reworked swap agreements to exclude the use of bonds sold by France, Italy and other southern European governments as collateral against equity derivatives, interest-rate swaps and repurchase agreements, or repos, Chief Executive Officer Lars Rohde said. Hilleroed, Denmark-based ATP holds 173 billion kroner of collateral, according to its 2011 half-year report.
“We have changed the contracts,” Rohde said in an interview with Bloomberg’s Risk Newsletter this week. “We put ourselves in a position where we only receive the very highest quality collateral, which is German, Danish and U.S. government bonds.”
The cost of insuring against default on French debt almost trebled in the past six months amid concern the nation will lose its top credit rating while having to bail out lenders hurt in the sovereign crisis. Italy, whose government-bond market is the third-largest with 1.6 trillion euros ($2.2 trillion) outstanding, was downgraded by Moody’s Investors Service for the first time in almost two decades this week.
Funds’ demands to receive only a limited range of government notes as collateral may make it harder for banks that rely on pledging sovereign bonds to get money.
These demands are on top of a decision by LCH.Clearnet Group Ltd. to impose a 5 percent initial margin increase on Italian bonds used for repo loans, which took effect on Sept. 22 before being reversed a few days later. Clearinghouses charge an initial margin to banks that want to use bonds to back repo loans, and then apply a rate to the collateral to protect members and manage risk.
The increases in margin were related to changes in the volatility of government debt, according to John Burke, LCH.Clearnet’s London-based director of fixed income. The company has treated French and Italian debt in the same volatility bracket, and is in the process of changing the treatment based on higher volatility in Italian bonds.
“LCH is likely to increase Italian haircuts to the same level as that of Spain in the near future,” Nikolaos Panigirtzoglou, an analyst at JPMorgan Chase & Co. in London, wrote in a Sept. 23 report.
The largest holders of Italian government debt as of the end of 2010 were Intesa Sanpaolo SpA, UniCredit SpA, and Monte Dei Paschi di Siena SpA, according to European Banking Authority stress-test disclosures and subsequent filings. The foreign banks holding the most were BNP Paribas SA and Franco-Belgian municipal lender Dexia SA.
Increased collateral requirements hit Irish bonds in November, after LCH.Clearnet lifted the margin requirement on the debt three times to 45 percent. Collateral increases for Portuguese government bonds beginning in April this year prompted yields to rise.
“LCH collateral requirements have been a pro-cyclical factor in the case of Ireland and Portugal,” said Laurent Fransolet, a fixed-income analyst at Barclays Capital in London.
Further changes will depend on market indicators, according to LCH.Clearnet. The clearinghouse firm manages its collateral requirements by monitoring downgrades, bond yields and default risk, according to a risk-management policy document published in October 2010.
French Debt Swaps
Debt-insurance costs for European governments have surged this year as the sovereign crisis that started in Greece infected other countries in the euro region.
Credit-default swaps backing French government debt are at 173 basis points, up from 63 basis points on April 7, according to CMA. Contracts on Italy are at 445 basis points, from 132 basis points.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a contract protecting $10 million of debt for five years is equivalent to $1,000 a year.
Investors demand an extra yield of 0.78 percentage point to hold French 10-year notes instead of benchmark German debt, compared with 0.31 percentage point in April. The spread on Italian bonds is 3.6 percentage points, up from 1.32 percentage points six months ago.
LCH.Clearnet has said that trading at 4.5 percentage points over a 10-year AAA blended benchmark would mean “material” increases to its margin requirements.
“We are not in that territory for Italy yet,” said Don Smith, an economist at ICAP Securities in London. “That is an onerous level that begins to undermine the quality of the asset for holders.”
Spreads at that level may mean a 15 percent increase in margin requirements, according to Smith.
Sovereign yields aren’t the determining factor in setting margin requirements, LCH.Clearnet’s Burke said.
“We have discretion on establishing whether the yield has pushed decisively to the level where we would apply a significant increase to the sovereign risk framework margin,” he said.
Concern is growing that France will lose its top credit rating amid contagion from peripheral euro-region countries. The rescue of Dexia prompted speculation the government will have to bail out other banks.
Moody’s lowered Italy’s rating three levels on Oct. 4, to A2 with a negative outlook from Aa2, the first time it downgraded the country since May 1993. Standard & Poor’s cut the nation’s rating on Sept. 20 for the first time in five years.