Collateral agreements increase amid new regulations, ISDA survey finds

Judson Baker
Judson Baker says much of the change is because more market participants are signing collateral agreements as a best practice

Regulatory requirements and increased best practices in swaps and derivatives trading have led to increases in collateral agreements, whether the trades are centrally cleared or not.

Ninety-one percent of all over-the-counter derivatives trades, cleared and non-cleared, were subject to collateral agreements in 2013, according to the International Swaps and Derivatives Association's 2013 Margin Survey released April 10. That's up from 73.7% in 2012.

Also, 90% of non-cleared OTC derivates trades had such agreements, up 20 percentage points from 2012.

Non-cleared collateral as of Dec. 31 totaled an estimated $3.17 trillion — down 14% from the end of 2012.

Requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act and European Market Infrastructure Regulation were cited by survey respondents as the chief reasons that more market participants are using collateral agreements as a result of a shift to central clearinghouses.

However, much of the change is because more market participants are signing collateral agreements as a best practice, not just to meet regulatory requirements, said Judson Baker, senior vice president, corporate and institutional services, at Northern Trust Corp., Chicago.

“From a pension fund's perspective, the numbers (of those with collateral agreements) are growing such that you'd be kind of an outcast if you don't have a collateral agreement over the derivatives,” Mr. Baker said, citing the survey's report that 81% of non-cleared transactions by pension funds involved collateral agreements. “If they're not using one, you'd have to ask why. Of those 18% to 20%, why not have these agreements? What's holding them back? … They're otherwise going to have counterparty risk. It used to be dealers would be asking for collateral mostly from the buy side; that didn't affect pension funds. But now that we've experienced a dealer default, is it prudent for pension funds to do swaps without collateral agreements?”

Mr. Baker said since Dodd-Frank requires that interest-rate and credit-default swaps must be cleared through central counterparties, pension funds generally outsource such trading because of how onerous the trades can be if done internally. “What pension funds need to know (with swaps) is that the investment manager has to deal with this and if they're not, they need to question why they aren't collateralizing.”

Among the other ISDA survey findings:

  • Eighty-seven percent of non-cleared OTC derivatives collateral agreements involved portfolios of fewer than 100 trades last year, while only 0.3% involved portfolios of more than 5,000 trades.
  • On an asset-class basis in 2013, 97% of all bilateral transactions involving credit derivatives and 86% of such transactions involving fixed-income derivatives were made under a collateral agreement.
  • Daily reconciliation rose 5% for portfolios consisting of 100 to 499 trades at the end of 2013. Eighty-four percent of those surveyed indicated they reconcile their portfolio mix on a daily basis.

Of the 61 firms responding to the 2014 ISDA Margin Survey, conducted earlier this year, 87% were banks and broker-dealers. The remaining participants consisted of money managers, hedge funds, insurance companies, sovereign wealth funds and other government-sponsored entities, master trust banks and buy-side institutions.