Sovereign two-way CSAs would probably resemble one-way posting, says Dutch DMO

High thresholds would reduce credit and funding benefits of two-way CSAs for banks, DSTA head says

Reciprocal collateral agreements between sovereign swap users and dealer counterparts would probably not be radically different to one-way credit support annex (CSA) agreements, says Erik Wilders, head of the Dutch State Treasury Agency (DSTA) in The Hague.

"In theory, if we were to sign two-way CSAs with swap dealers, the agreements would have to provide enough warranties to ensure we never get exposure to the credit risk of a bank. In other words, the CSAs would have very high posting thresholds, which ironically would probably end up resembling one-way CSAs. This would negate the funding and credit risk advantages of the two-way contract for banks. That said, it is plausible that in a trending environment with severe moves, thresholds could be breached and we would end up posting collateral," he says.

Most sovereign entities insist banks post collateral when the present value of a trade is in the sovereign's favour, while refusing to reciprocate if the value swings back the other way - a one-way agreement that insulates the sovereign against the risk of a dealer collapsing. However, this leaves the dealer with capital and funding costs. Those costs have grown during the crisis and will be hiked further when new regulations are implemented.

However, Wilders explains that if a bank were to insist on a two-way CSA with relatively low thresholds - where the sovereign would post collateral following a relatively small swing in the dealer's favour - the pricing of the swap would have to take into account the differential between the credit spread of the sovereign versus the bank, which would allow for a sizeable deduction in the swap price.

"The pricing would have to take into account credit default swap spreads, which will make the swap price cheaper for the sovereign. If banks won't want to do that, the CSA will end up being one where it is near impossible for the sovereign to get exposure," he says.

In other words the CSAs would have very high posting thresholds, which ironically would probably end up resembling one-way CSAs

Some swap dealers have said the price of swaps based on one-way CSAs will increase - and this has persuaded some sovereigns, such as Portugal, to switch to two-way CSAs.

However, the DSTA only has one-way CSAs and says swaps prices haven't been increased. "Yes, we have had discussions with all our dealers about swaps prices in one-ways CSAs and the possible move to two-way collateral posting, but overall the prices in the swaps we have transacted remain the same. Some dealers are adding a bit of margin to the charge but largely the group prices competitively," says Wilders.