Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

It's hard to overstate the complexity of new regulations that are transforming the financial industry.

Some of the biggest changes are taking place in the derivatives market, where new rules are requiring firms for the first time to post hundreds of billions of dollars in collateral to protect against systemic shocks. This collateral typically takes the form of cash or securities that can be liquidated quickly, such as government bonds. 

The goal is laudable: to cushion against losses and firm failures when leveraged wagers go belly up. The result is a bit messy. Firms now have to become cash managers in a way some of them never have before, and they have to meet increasingly high hurdles when it comes to back-office compliance.

Let's consider what counts as collateral: Cash or cash-like securities, including short-term Treasuries. Here's the problem: U.S. government bonds are quite different from cash when you look under the hood, at least when it comes to the back-office operations involved with trading them. They're often not traded electronically. Some are centrally cleared, some aren't. They have different maturities that all need to be accounted for. At times, it can be hard to find a willing seller.

All this translates into a significant cost, especially as the new rules go into effect and firms try to work out the kinks to make their processes more efficient. As just one example, the Federal Reserve estimates that firms will have to post $315 billion of new collateral in the over-the-counter derivatives market alone, for a total annual cost of about $2.5 billion.

Letting Out Steam
The over-the-counter derivatives market has been shrinking as new regulations get implemented
Source: Bank for International Settlements

The costs are big enough, and guarantee enough inefficiency, that some firms are seeing ways to profit from it. One is Goldman Sachs Asset Management, which last week announced an exchange-traded fund that is specifically aimed at easing some of the complications in using short-term Treasuries as collateral. It's betting that investors are willing to pay a small fee to sidestep the back-office headaches.  

Goldman's new fund, its first fixed-income ETF, trades under the ticker GBIL, with the goal of tracking the Citi U.S. Treasury 0-1 Year Composite Select index. The pitch to investors is that it's a vehicle to bypass the complications of trading short-term Treasuries by trading a stock-like ETF instead.

It has a unique feature intended to make it easier to use for collateral purposes, but it's not the first ETF of its type. BlackRock's iShares Short Treasury Bond fund, for example, was created in 2007 and has $3.4 billion under management. And these ETF shares may be difficult to use as a proxy for the actual Treasuries when posting margins in some places.

Sweet Spot
Debt investors have gravitated toward ETFs as an easier way to access even short-term bonds
Source: Bloomberg

Still, the new fund is notable because it underscores a growing concern for markets worldwide. How will firms, from hedge funds to big asset managers, post an increasing amount of collateral for derivatives trades at a time of limited government-bond supplies and changing cash-management behaviors?

These new rules will help prevent systemic seizures like the ones that led to the financial crisis in 2008. But they have consequences, especially at a time when debt markets are somewhat strained. The increasing plumbing costs are real enough that firms see an opportunity in fixing small leaks along the way.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net