The looming VM crisis, reviewing Emir and delaying FRTB

The week in, May 19-25 2017

SWAP unwind fears loom ahead of VM deadline

FRTB deadline extension considered by EU lawmakers

EMIR review could push securitisations into the dark


COMMENTARY: The tighter the grip, the more slips through

The proposal to review the European Market Infrastructure Regulation (Emir), which came out earlier this month, highlights another example of a fundamental problem regulators have been battling for most of the past decade. The review suggests redefining securitisation special-purpose vehicles (SSPVs) as financial counterparties under Emir. This would not compel them to go through clearing for their hedging transactions – another change introduces a minimum size for the clearing requirement – but they would need to start posting initial and variation margin. (Yes, it’s yet another problem associated with variation margin (VM); the repapering exercise mandated by VM rules for non-cleared swaps is still causing trouble.)

Funding this in advance by the originator – from the payment stream of the SPV’s assets, from cash reserves built up over time, or by a pre-arranged third-party liquidity agreement – are all possible, but all have disadvantages. The end result, many practitioners say, could be a significant blow to the revival of securitisation in the European Union – something the EU has been pushing for with its proposal for “simple, transparent and standardised” securitisation rules. But these rules would require SPVs to hedge their interest rate and currency risk in order to qualify – running them headfirst into the margin requirement proposed in the Emir review.

So the outcome of the new margin rules is likely to be the reverse, many fear. Instead of securitisations becoming simple, transparent and standardised, they are likely to be largely replaced by private placements, which won’t be required to post margin. But they will also be far more customised, potentially more complex, and, most seriously, more opaque than securitisations. This is bad for a number of reasons – whether or not the EU is right to want to revive securitisation issuance, which stands now at barely a quarter of its pre-crisis peak, no-one wants to see the development of a new industry in which banks will create unmapped and obscure exposures to a sort of black market mortgage-backed security. That sounds bad for price transparency and, more seriously, terrible for systemic stability. Squaring this particular circle won’t be easy, but it needs to happen soon.



Junk bond yields have dropped from around 10% in early 2016 to below 6% this month, while option-adjusted spreads are hovering around 3.7% – the lowest level since mid-2014. Meanwhile, US-listed bond ETFs of all types pulled in nearly $100 billion in 2016, according to Morningstar. These funds now have total assets of almost $500 billion.



In our opinion, there are two core misunderstandings about operational risk capital behind [Jamie] Dimon and [Peter] Sands’ positions: that operational risk is a different class of risk, with no risk/return trade-offs, and thus doesn’t require dedicated capital; and that operational risk capital and sound risk management are substitutes for each other, rather than complementary – Ariane Chapelle and Evan Sekeris

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