The swaps market is still waiting on final margin rules, an area of concern for securitization players.
And thanks to a standoff between European and U.S. regulators, they’ll be waiting a bit longer.
Swaps listed in a counterparty clearing house (CCP) are required to post margin — basically additional cash that cushions against risk. Those that are uncleared don’t face this requirement. The vast majority of swaps taken out by securitization vehicles are uncleared.
But the anxiety about the potential for a margin requirement for uncleared swaps has been dogging the industry for some time.
More definitive rules on this front are being largely held up by the same forces delaying most regulations concerning swaps: a years-long standoff between regulators in the U.S. and Europe over how to regulate the swaps market.
“The margin rules haven’t been adopted yet,” said Marc Horwitz, a partner at DLA Piper, who added that the Commodity Futures Trading Commission (CFTC) has most recently indicated that will happen at the end of the year thought there have a number of delays.
“There’s a big concern that if the U.S. adopts final margin rules that are inconsistent with the EU and other jurisdictions that have swap trading rules, that’s going to create a lot of uncertainty,” Horwitz added.
Swaps are agreements to exchange one set of cash flows for another. They are commonly used to protect against interest rate mismatch in a deal that pays a fixed rate of interest but is backed by floating-rate loans, for instance. This can raise the credit quality of a deal to a point where it is palatable to target investors. The same goes for a security denominated in a different currency than the underlying collateral.
To be sure, collateral concerns aren’t only affecting uncleared swaps.
There are worries that CCPs may not yet be collecting enough collateral to ride out an extremely high-stress event. The Office of Financial Research issued a pair of papers in May that said the standardized approach to calculating margin may not adequately protect CCPs from the risk of clearing member default.
And Federal Reserve Gov. Daniel Tarullo noted the possible shortcomings of CCP capitalization rules in a speech in January, saying that it is "worth considering whether this standard is adequate when hypothesizing stress throughout the financial system."
U.S. regulators met earlier this month with their European counterparts to discuss cross-border swaps regulations, and the outcome was notably vague; regulators "held productive discussions" that "were continuing in a constructive manner" and "discussed the evolving E.U. and U.S. approaches and options for cross-border cooperation," according to a Sept. 23 report from the Treasury.
Observers said the conflict between the U.S. and Europe over swaps regulation is hotter than it appears on the surface. The U.S. has moved faster on derivatives regulation than Europe and has proposed, in some cases, to have swap dealers register with the CFTC if they want to access U.S. markets. Europe, for its part, has withheld recognition of U.S. clearing houses and exchanges over concerns that their margin collection is inadequate. CFTC and Treasury officials did not respond to requests for comment on the state of negotiations with European regulators.
"Big picture, this is about a trade war," a regulatory attorney said. "At the end of the day there are only two rules that really matter, capital and margin. If somebody has an advantage on either of those two rules, it is a massive competitive advantage."
While securitization players might not be as concerned about the capitalization of CCPs, any shifts in margin requirements are on their radar, particularly if those influence what’s happening in the uncleared markets.
Keeping securitization-linked swaps free of margin requirements is seen as essential for a viable market in certain asset classes.
In a Nov. 2014 letter to regulators, the trade group Structured Finance Industry Group argued that requiring ABS vehicles to post margin would increase the costs for issuers to the point where securitization would be unviable for some asset classes.
Last May, captive finance companies — including prolific auto-loan securitizers — were given an exemption by the CFTC to having to clear the swaps in their asset-backed vehicles. So, for the time being, they can avoid posting margin on these arrangements.
Margins aren’t the only reason asset-backed players want to avoid having to clear swaps taken out by asset-backed vehicles. Other kinds of flexibility matter as well. Securitization swaps tend to be bespoke and would have trouble fitting into the more standardized formats required by clearing.
But of course fears of having to clear an ABS swap would be moot if they were required to post margin regardless.
A recent proposal from the CFTC about extending a proposed rule on margin requirements for all swaps to cross-border swaps suggest the agency may be reticent to provide carve outs.
Requiring margin on ABS deals may not kill the industry but it could drastically reduce swap usage.
“These deals aren’t set up for cash collateralization,” said Horwitz. “Forcing a swap like that into clearing; basically people wouldn’t do them.”