Germany’s debt management agency is set to pledge collateral against some of its derivatives trades for the first time in a sign even Europe’s safest borrowers see scope to cut transaction costs with guarantees.
The Federal Finance Agency, which manages the Finance Ministry’s budget and short-term liquidity funding, plans to increase savings on the interest-rate swaps it currently uses by offering collateral on as much as 8 billion euros ($10.9 billion) of the trades as early as next year, agency spokesman Joerg Mueller said July 5 by phone. The agency may at the same time opt to use a central derivative clearing house in London and appoint a company such as Eurex Clearing AG to settle the transactions, he said.
While Europe’s benchmark issuer has leaned on its AAA credit rating to avoid posting collateral on its debt in the past, buyers of one-way collateralized swaps and regulators are demanding more guarantees to limit risk. German lawmakers, in a revised 2014 budget on June 27, approved the backstops that can be transacted from next year.
“The market would seem to be moving somewhat toward two-way contracts since the debt crisis, creating the bonus of added stability,” said Vincent Chaigneau, global head of rates and foreign-exchange strategy at Societe Generale SA in Paris, in a telephone interview on July 2. “The assumption is that Germany aims to pay less by posting collateral than not.”
Germany pays the lowest interest on its bond sales in the euro area, reflecting the perception of the nation as the most credit-worthy in the currency bloc, and its use of collateral may set a precedent for other euro-area nations.
Clearing the swaps centrally is as important as seeking additional savings, said Mueller. “We know that central clearing will become the most important way of trading and settlement for all major swap market participants going forward,” he said. The agency wants to clear swaps centrally as early as next year though only on the proviso it can offer collateral at the same time, he said.
The Finance Ministry has approved the debt agency’s use of the new swaps to boost Germany’s “benchmark position and favorable financing conditions on the capital market,” it said in a June 25 e-mail.
The yield on German 10-year government bonds was little changed at 1.26 percent at 4:06 p.m. Frankfurt time, within 14 basis points of the record-low 1.127 percent reached in 2012. The nation’s securities returned 4.7 percent this year through July 4, Bloomberg World Bond Indexes show.
Germany started contracting swaps linked to foreign-currency bonds in 1999, kicking off the current program of trading one-way collateralized “plain vanilla” swaps in 2008. The move was linked to the development of derivative instruments in global financial markets before the 2008 collapse of Lehman Brothers Holdings Inc. The agency’s swap portfolio had a nominal value of about 240 billion euros at the end of last year, according to its website.
The swaps typically trade fixed interest-rate payments on bonds for floating rates with the aim of enabling the seller and the counterparty to mutually reduce risk.
Costs for some swap transactions increased after policies were introduced to tighten and align rules for over-the-counter derivatives after Lehman’s demise.
Germany’s decision to provide additional security on its interest-rate swaps echoes steps by countries including Denmark and the U.K., which started offering two-way collateral on derivative trades in 2013 and 2012, respectively.
Denmark stipulates that collateral must be in the form of a cash deposit of kroner. The central bank in Copenhagen switched over half of its one-way contracts to two-way contracts by the end of 2013, it said on its website.
The move is “to be welcomed in general,” the BDB lobby group for commercial banks in Germany said in a July 1 e-mail.
“Derivatives transaction costs are directly reduced for banks and indirectly cut for the government,” said the Berlin-based group, which represents lenders including Deutsche Bank AG and Commerzbank AG.
The decision could trigger increased use of collateral “as other states and state-guaranteed institutions may be forced to follow this step,” BDB said.
Valuation changes of some over-the-counter derivatives crimped earnings at investment banks including JPMorgan Chase & Co. Deutsche Bank’s fourth-quarter pretax loss of 1.15 billion euros was driven by 623 million euros in charges for adjustments in debt, credit and funding valuations, according to Commerzbank analysts.
From 2015, banks, over a four-year period, must back trades in the $633 trillion market for swaps and other over-the-counter derivatives with additional collateral, according to plans jointly issued by two groups of international standard-setters in September. Traders will be allowed limited scope to use collateral they are awarded to back other trades, according to the Basel Committee.
The Finance Ministry last week began to draw up the 2015 budget that’s set for completion in December.