Rules requiring banks to hold more capital to cover their derivatives activities could lead to more exits from the clearing space, argues PIMCO.
According to the world’s largest fund manager, the capital rules set out by the Basel Committee on Banking Supervision (BCBS) fail to treat collateral, posted by bank’s customers, as a sufficient buffer to reduce overall risk.
“The rules as they are currently constructed would prevent banks, when acting as clearing brokers, from receiving ‘credit’ in their leverage ratios for segregated initial margin posted by their clients, thereby requiring them to hold more capital for these transactions even though segregated initial margin expressly mitigates risk,” says PIMCO executives Libby Cantrill, William De Leon, Tracey Jordal and Courtney Walker wrote in an online paper.
The capital rules also require banks to fund both initial and variation margin at long-term funding rates, increasing costs significantly.
This means banks have two choices: either pass down the added costs to their end-user customers (such as PIMCO) or leave the derivatives clearing business entirely.
“Having fewer clearers would be unwelcome, as it would consolidate risk among fewer members and make ‘portability’- the ability to transfer trades from one bank to another and an important element of clearing- significantly more difficult,” the paper adds.
According to a report from TABB Group there are now 49% less U.S. registered clearing brokers, following the exit of 15 futures commission merchants (FCMs) in the fourth quarter of last year. Most notably, BNY Mellon and State Street closed their U.S. and European derivatives clearing business last year.
As well as PIMCO, CME Group and even Timothy Massad, head of the U.S. derivative regulator the Commodity Futures and Trading Commission (CFTC), share similar concerns over the consequences of the Basel III capital rules.
“I’m very concerned that this could have a significant negative effect on clearing,” he said at a Congressional hearing in February.
This story first appeared on our sister site Global Custodian.com