As much as $6.7 trillion in additional collateral may be needed to satisfy new bank capital rules and swaps-clearing mandates, according to securities-industry consultant Finadium LLC.
Scarcity of cost-effective assets to back swaps trades has led some market users to engage in so-called collateral transformation, in which lower-rated securities are exchanged for cash or highly rated securities, the Concord, Massachusetts-based firm specializing in securities lending and collateral management said. The extent of that transformation will depend on whether banks and money managers believe too few assets are available to cover their swaps positions, Finadium said.
“This trend will continue strongly through 2013 so long as current regulations support a required increase in cash and government bonds for collateral and balance sheet purposes,” the firm said in the report.
The U.S. Dodd-Frank Act and international regulations under the Basel III accords are mandating the use of clearinghouses for most swaps, which require upfront collateral, and prodding banks to increase the amount of capital they hold against losses.
The new bank-risk rules will compel lenders to keep more cash and easy-to-liquidate investments on hand for emergencies. That may boost demand for high-grade assets by $2 trillion to $4 trillion, according to an April report from the International Monetary Fund.
Finadium said the range of collateral needed may be between $3.6 trillion and $6.7 trillion.
At the end of 2011, the IMF said there were $33 trillion in outstanding government securities rated AAA to AA that had been issued by the 34 countries in the Organization for Economic Cooperation and Development, according to the report.
“There is no question that from a numerical standpoint, enough collateral exists worldwide to accommodate even the worst of collateral shortages,” Finadium said.
Swaps users and banks may not have access to those securities when needed, the consultant said.
“Substantial work may be required in order for collateral posters and banks to actually get assets,” it said. Securities lending and asset repurchase agreements “play a key role in the collateral transformation process,” Finadium said, and those businesses “could become important paths of access.”