Swaps trading, range accruals and manufactured defaults

The week on Risk.net, April 6–12, 2019

7 days montage 120419

Risky notes replace easy money for exotics desks

Dealers insist ‘it’s different’ as flat US curve revives bonds that sank the Street in 2008

CFTC official warns on Sef rule overhaul

Isda AGM: Targeted changes better than a total rewrite, says Rostin Behnam

Isda’s CDS fix draws murmurs of dissent

Proposed changes don’t go far enough for some; others say it will block legitimate activity


COMMENTARY: The wrong range accrual risk

The demand for Formosa bonds is drying up thanks to a regulatory change in Taiwan, and US banks’ exotics are turning to riskier alternatives to replace the lost revenue stream – range accrual notes are in for a revival, providing the prospect of a steady income stream from the flattening US yield curve to the investors who are piling in.

As Risk.net reports this week, there are reasons to be cautious of range accruals. They can be hedged, but the hedges have a nasty habit of breaking down as soon as the yield curve inverts too far – for example, in or before a deep recession, at which point everyone’s hedges break down simultaneously. It’s a structured finance triumph – a product that is perfectly safe to issue except when you really need it to be perfectly safe. The last time that happened was when euro yield curves became deeply inverted in 2008 – the losses mounted into the billions for the European exotics desks involved.

Naturally, the people involved in the newly flourishing range accrual market insist this time will be different, that they have learned their lesson and are now much more cautious. Being sceptical is only reasonable; the history of finance is full of people making exactly the same mistake over and over again.

But even if the assurances are reliable, there are still good reasons to worry about the sudden boom in range accruals. Any rapid increase in product sales should ring alarm bells – is there a risk that the new customers are buying products that are not entirely suitable? This is a vital concern for retail product markets, but it’s not ridiculous to ask the same question even of sophisticated investors.

And the range accruals will, exotics desks admit, not fully replace the steady and significant revenue stream coming to those desks from Formosa bond sales – until the middle of last year. This should be raising warning flags as well. Just as when economic growth starts to slow (which also seems to be happening), the sudden loss of a revenue stream will put pressure on desks to find new income. This could lead to corners being cut.

Less due diligence, less attention to risk management, and less notice of tail risks will follow – this, rather than anything related to the product specifically, could be the real risk behind the range accrual boom.



Regulatory adjustments disqualified one-fifth of large European banks’ Common Equity Tier 1 instruments and reserves from counting as Basel III-eligible capital in 2018. Aggregate CET1 capital held by the 11 global systemically important banks in the European Union stood at €811.9 billion ($911.9 billion) at the end of 2018. After regulatory adjustments this total dropped to €649.9 billion



“European authorities seem to be able to move quickly when legislators are all in agreement, but in other circumstances [they move] more glacially. I don’t think these no-action powers speak to speed, and it is potentially quite clunky” – Tim Cant, Ashurst


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