Tabb Group have conveniently published an excellent explanation of the collateral crunch theory as explained by Miles Reucroft who neatly explains the perfect storm of increased demand for collateral due to impending mandatory OTC clearing and bilateral margin, with reduced availability of eligible collateral due to quantitative easing. Reucroft also gives some ideas as to how collateral conversion may help, and its limitations/risk. See here on the Tabb Group site.
I attended the FIA Europe Power Trading Forum on the 26th March. An excellent event where several trends were noteworthy.
Firstly several exchanges had been invited to give updates on their product roadmaps for the coming months and years including APX, CME, EEX, Nasdaq & Nordpool Spot. The aggressive level of planned competition was notable with pretty much everyone in the process of launching new cleared products in gas and power in Europe and/or the US. CME are entering the European market as a greenfield provider, and EEX, having launched an NBP Natural Gas contract on the same day, declared that cleared UK Power was ready in the wings, while Nasdaq is launching US Energy products against Brent, WTI, & HH.
There was also a general feeling that a general move to cleared exchange traded and bilaterally margined products would lead to a collateral crunch, possibly within two years. The lack of easily available eligible collateral is also an opportunity that the banks are looking forward to exploiting with collateral transformation services. Despite the continued depressed oil price, some commodity firms would appear to remain a good risk for banks, with Trafigura announcing a new revolving credit facility of $5.3bn the same week. Inventory, cargoes, and receivables all form excellent sources of working capital for conversion to eligible collateral using financing, repos and so forth.
The physical trading participants themselves were of course also focussed on REMIT reporting issues. There is a risk of complacency here. Just because budgets are in place and an EMIR-like reporting programme now feels familiar, it does not mean there aren’t a lot of critical risks/uncertainties to address and decisions to make promptly if you want to hit the deadline!
Ever more corporate working capital is tied up in margin, and the cost for banks of uncollateralised trading is becoming ever more transparent.
Risk.Net reports today that Goldman client margin soared $4.5bn last October, and that Morgan Stanley provided $468m funding cost against uncollateralised receivables on derivatives. With the movement on currencies and commodities prices in the meanwhile margin calls will only have gone one way.
The business case for corporates improving control over margin, minimising the quantity and optimising the type of collateral delivered (cheapest vs. easiest) is ever stronger.
There is plenty that can be done, perhaps the cash crunch that will result from falling commodity prices will be the final straw to persuade CFOs to ask for improvements?
See here for the Risk.Net articles.