Volatility could limit banks’ buy-side support

Industry fears are growing over potential impacts of high volatility on banks' ability to support asset managers’ OTC derivatives trading and clearing.

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Industry fears are growing over potential impacts of high volatility on banks' ability to support asset managers’ OTC derivatives trading and clearing.

Banks face growing pressure to lower the amount of capital used to support client swaps activity as part of post-crisis reforms to reduce systemic risk, which could be exacerbated by changes to volatility.

Although the market has shown an aptitude to transition to central clearing of OTC derivatives and trading on new swap execution facilities (SEFs), Piers Murray, global head of fixed income prime brokerage for Deutsche Bank, suggested a shift in volatility could alter banks’ ability to meet the risk management needs of their buy-side clients and new rules.

“Banks and their affiliated clearing members are under increasing capital restraints that may be heightened with any increase in market volatility,” Murray said. 

Although currently low, market volatility has increased in recent years due to concerns about the stability of the eurozone and the start of reducing quantitative easing in the US. 

He added that so far, both buy- and sell-side firms had reacted positively to the adoption of central clearing of OTC derivatives and SEF-based trading.

“In the US, virtually all asset managers are up to speed with central clearing, but many are grappling with the necessary operational changes to centrally clear certain products, and additional functionality such as bunched orders,” he said.

A bunched order is an order executed by an account manager on behalf of customers and allocated post-trade to individual customers. The bunched order is cleared first by an initial clearing firm and then by an ultimate clearing firm that holds accounts for individual customers.

Rules within Basel III will also add further strain on banks’ ability to support buy-side swaps trading and clearing needs.

On Thursday, the Basel Committee published a final rule govenring how much money banks will need to support their swaps businesses, watering down a previous proposal. Now, banks will be required to apply a 20% risk weighting to cash deposited at central counterparties, down from the 1,250% level outlined in the June 2013 plan.

But, despite this apparent softening of the rules, a ratio within Basel III that seeks to reduce the amount banks can leverage is expected to limit banks' ability to take on risk.

On Wednesday, US banking agencies finalised higher leverage capital standards for the eight US banks designated global systemically important banks. In line with a July proposal, these banks will have to maintain a supplementary leverage ratio of 6% to be considered ‘well capitalised’ for regulatory purposes. 

Although implementation of the leverage ratio has begun with banks reporting to national bodies, public disclosure will begin in January 2015, and a final ratio will be set after calibration by 2017 for which banks will have until 2018 to meet.

In January, the Basel Committee released the full text of the leverage ratio framework and disclosure requirements.

“This simple, non-risk based ‘backstop’ measure will restrict the build-up of excessive leverage in the banking sector to avoid destabilising deleveraging processes that can damage the broader financial system and the economy,” the Bank of International Settlements said in a January statement explaining the ratio.