Variation margin collateral will be ‘huge challenge’

Variation margin collateral will be ‘huge challenge’

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The impending key deadline for the collateralisation of non-cleared derivatives under EMIR has reawakened fears that there may be a shortage of eligible assets to cover trades, delegates heard at the Global Custody Forum in London yesterday. 

The EU regulation requires counterparties, which exceed certain thresholds, to collateralise non-cleared derivative transactions, with initial margin at the opening of the trade and topped up with variation margin on a daily basis.

The requirements are gradually being phased in but March 2017 is a key date as this is when all counterparties will be required to post variation margin.

“This is a huge big bang,” said Ted Leveroni, chief commercial officer, DTCCEuroclear GlobalCollateral.

“March is a huge challenge. The buy-side community and custodians see three big challenges – repapering, the increase in the volume of collateral transactions and the decreased settlement period.” 

“Dealers are dealing with thousands and thousands of entities and they are going to have to repaper all of them.” He said that while some firms may have the resources and “bandwidth” to cope with repapering, the entity on the other side of the trade may not “and they are going to have to prioritise who they are going to repaper with”.

He estimated that there would be a huge increase in the volume of collateral transactions – calls could be “two, three or four times” current levels.

The new requirement will increase the demand for eligible assets, high quality liquid assets (HQLA), by a large but unknown amount. While a collateral squeeze is undesirable it could be alleviated through securities lending and benefit owners of eligible assets.

Jan Heckler, managing director, head business services asset management, Swiss Re said: “The prices of HQLA are increasing so owners can potentially benefit from this. However, what we also saw when we tried to recall these securities is that it is really difficult to do so on time.”

A number of regulations – from EMIR to Dodd-Frank and Basel III – have increased the demand for HQLA leading to widespread predictions a few years ago that they would create a collateral squeeze and therefore higher fee rates. It has so far has not happened but additional demand is on the verge of emerging.

Bill Foley, director, Foley O'Neill, added: “Those rates had not actually kicked in – they were always on the horizon. People became a bit complacent but these are very much in front of our faces right now. In terms of securities lending, there are potentially some very, very healthy returns available.”

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