Insurance Companies, OTC Derivatives and the Collateral Upgrade Trade
Finadium
August 2011
As Dodd-Frank, Basel III and Solvency II start to become a reality for insurance companies worldwide, these investors are looking at a wide array of impacts to their business models. At the operational level, insurance companies have begun to focus on the practical implications of selecting an OTC derivatives clearing agent. They are also considering collateral upgrades, also called collateral conversion or collateral transformation trades, to supplement their scarce supply of cash and government securities for posting to a central credit counterparty (CCP) or to bilateral counterparties.
While US insurance companies hold only 0.18% of global OTC derivative contracts, they are perceived as major market participants due to their widespread and sophisticated use of these products. Life insurance companies in particular are an easily identifiable group of investors with specific needs in the interest rate swap and foreign exchange forwards markets.
Insurance companies typically have sufficient collateral at the holding company level to manage their OTC derivative margin obligations. However, the matter becomes complicated when individual subsidiaries find themselves under-collateralized for specific obligations or the holding company wants to reserve its liquidity for more urgent needs. US insurance companies in particular favor corporate bonds for their investments, leaving some firms with insufficient cash or treasuries to post on a CCP as new OTC derivative clearing rules come into effect.
This report has been written for insurance companies, their banks, clearing agents, technology vendors and advisors. It provides a peer analysis of the thinking of insurance executives and quantitative data on the holdings and collateral opportunities of US insurance companies. It also offers current pricing information on the OTC derivatives clearing market and suggestions for best practices in managing collateral for OTC derivatives.
This report is 25 pages with 16 exhibits.
TABLE OF CONTENTS
■ Executive Summary
■ The Depth of Regulatory Change
– The Demand for Collateral
– Methodology
■ Insurance Company Participation in the OTC Derivatives Market
– Executive Opinions on OTC Derivatives
– Selecting a Clearing Agent
■ Insurance Companies and Securities Lending
– The Collateral Upgrade Trade
■ What Matters for Insurance Companies, Banks and Securities
Lending Agents
■ About the Author
■ About Finadium