NSFR pricing Singapore banks out of swaps market, dealers say

Market share in long-dated trades has halved since metric was imposed at start of year

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Singaporean banks claim they are being priced out of Asia-Pacific swap markets as a result of their home state’s decision to introduce a key liquidity rule ahead of competitor jurisdictions.

Authorities in Singapore, Australia and Hong Kong chose to implement the net stable funding ratio, one of two liquidity metrics devised by global standard-setters as part of the Basel III measures, in January 2018. Europe and the US are not expected to finalise their versions of the rule before 2021; Canada is eying a 2020 start date.

The ratio encourages banks to shift to longer-term funding sources, which are often more expensive. Even passing on to clients a two-basis point rise in funding costs is enough to price a local bank out of a trade, dealers say. DBS claims it has had to cede market share in longer-dated swaps – those with maturities of more than five years – to US and European peers.

“We have sacrificed some long-dated transactions where the pricing does not work having considered increased regulatory cost,” says Thio Tse Chong, DBS’s managing director of treasury and markets. “Our perspective of cost to the transaction has changed versus other banks that do not have to comply with the same regulation. Reduced return from the crimped prices does not compensate us for the risk that we take.”

Singaporean lenders claim they face the biggest impact, with long-dated swaps volumes having halved since the liquidity metric was implemented, according to traders. Australian banks have fared better, market participants say, since they enjoy a broader funding mix and are less reliant on domestic interbank lending and short-term deposits to fund positions.

The three largest lenders in the city-state – DBS, OCBC and UOB – had a combined S$2.1 trillion ($1.5 trillion) in underlying notional value of interest rate swaps on their books at the end of 2017, according to their annual reports.

The NSFR aims to wean banks off short-dated interbank lending and replace it with longer-term sources of funding, which regulators deem to be more stable. Under the rule, a bank’s available stable funding (ASF), made up of liabilities including deposits and wholesale borrowing, must match or exceed its required stable funding (RSF), made up of assets and off-balance sheet exposures.

Most internationally active banks already meet the mandated 100% ratio. But many early adopters in Asia-Pacific say they have chosen to build a buffer above the minimum regulatory requirement in order to maintain greater flexibility for their day-to-day funding needs (see chart).

The buffer comes at a price. Ang Suat Ching, OCBC’s head of corporate treasury, says the switch to longer-term sources of funding will translate to higher costs for the bank’s trading businesses: “As these stable deposits typically cost more, it is likely that banks, including OCBC, will see an increase in the funding cost of the trading business over time.”

OCBC’s ratio stands at 108%, with DBS and UOB at 110%, according to their latest earnings reports. In Australia, ANZ and National Australian Bank registered 115% NSFR, while the figure for Westpac and Commonwealth Bank of Australia was 112%.

In markets where banks traditionally funded trading via interbank borrowing or short-term deposits, lenders face a self-reinforcing effect whereby their peers are also obliged to meet the NSFR minimum, increasing the competition for these sources of longer-term funding and pushing up aggregate funding costs for all local dealers.

That means lenders may struggle when coming up against international peers not obliged to abide by the NSFR, says Eric Pascal, senior adviser for financial risk management at KPMG in Singapore: “I can see why the global banks have a slight advantage in terms of how they are managing the NSFR across jurisdictions.”

The effect is not a surprise for local firms. As far back as a year ago, bankers were expressing concern that early adoption of the rule in Asia might lead to a loss of competitiveness in the region.

The size of the local markets means the stakes are high. In Singapore, trading in interest rate swaps averages $56 billion a day, according to the Bank for International Settlements 2016 triennial derivatives survey. The region is a hub not just for Singapore dollar-denominated swaps but also for the yen, greenback, Korean won, Aussie and kiwi dollar rates trading. Hong Kong’s interest rate swaps market is larger, at $74 billion, while Australia stands at $51 billion. These three markets are, respectively, the fourth, fifth and sixth largest globally for interest rate swaps.

We will inevitably see an increase in deposit costs over the long term
Ang Suat Ching, OCBC

Australian banks say the impact of the NSFR on their swaps businesses hasn’t been as severe, because their market-making activities are more focused on three- to five-year swaps, which aren’t as price sensitive as longer-dated trades.

Australian lenders have also been helped by their broader funding mix. Most tend to rely on capital markets for as much as a third of their total funding and have taken advantage of current low rates to extend their funding tenor. For instance, Commonwealth Bank, the nation’s largest lender, in its annual results disclosure in August said the weighted average maturity of new long-term wholesale debt issued in the year to June 2018 was nine years. That extended the weighted average tenure of its wholesale funding portfolio to just over five years.

On the other hand, retail deposits have traditionally been the backbone of Singapore banks’ funding. While that shields them from the vagaries of credit markets, the deposits tend to be shorter term and the longer-tenor ones have become more expensive. The spread between the three-month and one-year deposit rate in Singapore – the rate banks have to pay out to depositors – had climbed to 24 basis points at the end of September from 16 basis points at the end of 2016, the biggest gap since July 2011, according to Monetary Authority of Singapore data. It was at 19 basis points in January 2018.

“The implementation of NSFR in January 2018 has resulted in increased competition for deposits, which are a source of stable funding,” says OCBC’s Ang. “Coupled with the growth in deposit alternatives such as Singapore savings bonds, and a rising interest rate environment, we will inevitably see an increase in deposit costs over the long term.”

An additional driver of Singapore banks’ higher costs stems from FVA, or the funding valuation adjustment. FVA reflects the costs and benefits incurred when uncollateralised derivatives are hedged with collateralised or imperfectly collateralised ones. If a bank was in-the-money with an uncollateralised customer, for instance, it would receive no collateral on that side of the trade and would have to fund collateral posted to its hedge counterparty.

Any higher funding costs stemming from the NSFR should also produce larger FVA costs and benefits, potentially making some transactions too expensive for banks to take on.

In DBS’s case, the bank has moved to flow business that is short-dated, or to fully collateralised long-dated transactions that are less affected by the increased costs of the NSFR. Such business has almost trebled, the bank claims, softening any revenue impact from missing out on the more costly uncollateralised long-dated transactions.

Rahul Advani, director of public policy for Asia-Pacific at the International Swaps and Derivatives Association, says NSFR early-adopters may experience funding constraints for longer-term derivatives.

“The way NSFR is calculated and the requirement of an add-on for gross derivatives liabilities means that pricing any long-term derivative becomes more complicated, because banks that are liable to the NSFR would need to ensure that they have stable funding for it,” he says. “It all depends on which market you are in and how you are regulated in that market.”

Editing by Alex Krohn

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