The Q3: 2012 Federal Reserve “Senior Credit Officer Opinion Survey on Financing Terms” report was released earlier this month. It included a special section on the types of assets posted against OTC derivatives, both on bilateral and with CCPs. The special questions are always the most interesting and this report was no exception.
From the report, “…dealers were asked about the types of assets currently posted as collateral by their clients and the types of assets the dealers themselves currently post as collateral to CCPs. In addition, respondents were also queried about their expectations for changes over the next year in the types of collateral posted both by clients to dealers and by dealers to CCPs…” Lets take a look at the responses.
Cash is king: looking at what clients post to dealers: “…all but two respondents active in this market indicated that cash currently accounts for at least 60 percent of the collateral posted, with nearly one-half of dealers noting that the share of cash was greater than 80 percent…” Treasuries – not so much. 2/3rds of the dealers said that UST Bills, Bonds and Notes comprised of less than 10% of the collateral posted by clients. 25% of the dealers pegged UST between 10% and 20% of collateral posted. And “…other U.S. government securities, corporate bonds, and equities each typically amounted to less than 10 percent of initial margin collateral posted by clients to dealers; a number of dealers indicated that they do not accept these types of securities…” 15% of the dealers don’t take “other U.S. government securities” from clients as collateral, 26% don’t accept corporates, and 42% don’t accept equities.
For collateral posted by dealers to CCPs, the story is similar. “…Nearly two-thirds of dealers indicated that cash accounted for at least 60 percent of the collateral they currently post as initial margin, with nearly one-half noting that the share of cash was greater than 80 percent…” and “…As it was the case with clients’ postings, about two-thirds of respondents noted that U.S. Treasury bills and longer-maturity U.S Treasury notes and bonds constituted less than 10 percent of the collateral they currently post to CCPs; however, a few respondents reported that U.S. Treasury securities accounted for a share between 40 and 60 percent…”
Looking forward, the dealers expectation of the amount of cash posted by clients was that 50% anticipated the percentage of cash would remain the same with the rest equally distributed between expecting the amounts rising and falling. About half of the dealers surveyed expected the percentage of US Treasuries posted by clients to go up. However “…In contrast to their expectations regarding changes to their clients’ collateral postings, dealers, on balance, did not anticipate much variation in the share of collateral they post to CCPs that is accounted for by U.S. Treasury bills and U.S. Treasury notes and bonds…”
How to read this data? First, lets assume that the people who filled out the questionnaires were the right people to ask. Second, the seemingly popular use of cash could be that is it simply more efficient given how low rates are. This will change when the cost of cash rises (although we should live so long). Third, given all the talk about collateral shortages and transformation trades coming down the pike, one would think that a lot more non-cash collateral is currently in play than indicated. We are reminded of the repo trader who said a lot of people are talking about transformation trades, but not a lot of people are doing them. Of course CCP clearing requirements haven’t taken full effect and the market dynamics are bound to change when they do. Some analysts think that many on the buy side have not done enough of their homework and may not be operationally prepared when the time comes to pony up collateral. Cash may be the path of least resistance for them, despite the expectation from dealers than clients will post more UST going forward.
What about other collateral – corporates, government paper not issued by the Treasury (e.g. agencies), and equities? It seems like either the dealers aren’t accepting that paper or just don’t see much of it. That may change a bit on the government side. From the report “…About one-fourth of dealers, on net, also anticipated an increase in the share of collateral posting that consists of U.S. government securities other than U.S. Treasury securities. Respondents did not, on net, expect much change in the shares of collateral consisting of corporate bonds or of equities…” All the talk about widening out acceptable collateral doesn’t seem to have made dealers optimistic about it being meaningful. (And European CCPs are still hoping their regulators will allow agency paper…corporates are but a twinkle in their eye.) The cost involved of taking corporate paper at the CCPs will be higher than taking USTs – perhaps by a lot. Those higher costs will be passed along. It will be interesting to see the cost of a corporate to UST collateral transformation trade when compared to the extra cost of giving corporates to CCPs who will accept them. Will clients who have corporates and want to use them as collateral in the CCPs who accept the paper avoid those dealers who waive that collateral off? Equities – probably not happening.
A link to the FRB report is here.