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LCH Raises Margin Costs for Trading Spanish Government Bonds

LCH Raises Margin Costs for Trading Spanish Bonds Amid Crisis
Spain became the fourth member of the 17-nation bloc to seek a bailout since the financial turmoil began almost three years ago when it asked for aid to rescue its lenders on June 9. Photographer: Angel Navarrete/Bloomberg

LCH Clearnet Ltd., Europe’s biggest clearing house, raised the extra deposit it takes from clients to trade most Spanish government bonds as concern mounts that euro-area leaders are failing to tame the debt crisis.

The margin needed for Spanish securities due in 10 years to 15 years will be increased to 14.7 percent from 13.6 percent, according to a statement on LCH Clearnet’s website yesterday, which was confirmed by Rachael Harper, a spokeswoman for the company. The rate was also boosted on all Spanish debt due from zero months through seven years.

Spain became the fourth member of the 17-nation bloc to seek a bailout since the financial turmoil began almost three years ago when it asked for aid to rescue its lenders on June 9. That helped send the yield on the 10-year bond to a euro-lifetime high of 7.29 percent two days ago.

“The LCH margin increase is part and parcel of a process where every institution involved in a given trade tries to protect itself, thereby accelerating the speed with which Spanish bonds fall,” said Sebastien Galy, a senior foreign-exchange strategist at Societe Generale SA in New York.

While the rate on the bond declined 41 basis points in the past two days to 6.75 percent at 4:36 p.m. London time, it is still close to the 7 percent threshold that helped trigger sovereign bailouts for Greece, Ireland and Portugal.

Yield Levels

Pacific Investment Management Co.’s Andrew Bosomworth said the borrowing costs of Spain and Italy are unsustainable.

“Both of those countries will go bankrupt eventually if they have to continually refinance themselves at these sorts of levels,” Bosomworth, a money manager at the Newport Beach, California-based company, said in an interview on Bloomberg Television’s “The Pulse” with Maryam Nemazee. “It’s not an easy environment to invest in.”

An increase in the margin requirement reduces the amount of cash banks are able to borrow using the Spanish government bonds as collateral in so-called repurchase operations, dimming their appeal, and meaning holders need to commit more of the securities to get the same size of loans.

The additional deposit required for trading notes due in 4.75-through-seven years will be 9.50 percent, from 8.10 percent previously, LCH Clearnet said. The changes will come into effect from the close of business tomorrow, the company said.

Credit Downgrade

Spain’s credit was downgraded three steps to Baa3 from A3 on June 13 by Moody’s Investors Service, citing the nation’s increased debt burden, weakening economy and limited access to capital markets.

The decision to increase the margin was predicted yesterday by strategists at Bank of America Merrill Lynch Global Research in an investor report.

“Yesterday’s LCH haircut increase shouldn’t have material impact on bank funding or on Spanish bonds,” said London-based rates strategist Sphia Salim in an interview today. “This is because it is very limited. What would be worrying for Spanish bonds and market confidence in general is if LCH Ltd raises the haircuts by 10-15 percentage points.”

The extra yield, or spread, investors demand to hold the 10-year bonds of Spain over similar-maturity AAA rated German bunds reached a euro-era record 589 basis points, or 5.89 percentage points, on June 18.

A spread of 450 basis points over a AAA benchmark is an “indicative level at which LCH Clearnet reviews margins held to ensure that enough financial resources have already been called to cover the associated reduced market liquidity,” according to the company’s website.

“LCH Clearnet looks at a variety of measures to understand market conditions and liquidity,” the company said. Because LCH Clearnet “proactively manages all markets to seek additional margin as spreads widen,” it may be that “no additional margin call is required by the time spreads have reached” 450 basis points, it said.

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