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Do swaps still work?

04 July 2014
Richard Kemmish


Except covered bond swaps, of course. The problem is we just don’t fit in. Covered bond swaps have too many odd features that break clearing house rules, like continuing after the death of the issuer, and not allowing two-way posting of collateral (and plenty of others, but I don’t want to bore you any more than is absolutely necessary).

Fortunately everyone gets this. Commission have told the supervisors who are responsible for the nitty-gritty details of EMIR – the rule book that insists on central clearing - not to be too beastly to the covered bond market (not the exact words that they used). But, as ever, the devil is in the detail.

For example, ok covered bond pools can ignore the requirement to post collateral (because they can’t take it out of the cover pool) but what about the other side of the swap? the investment bank that enters into the swap normally has to post their margining requirements into the cover pool to keep it away from the insolvency estate. 

Can investment banks divide their swap books into those that are part of a cover pool and those that aren’t? Even when their counterparty is the same legal entity. In theory yes but, speaking as someone who started their career in the swaps back office (oh, happy days), trust me, it isn’t going to be easy in practice.  

Then there are the limits on the number of non-cleared derivatives that a bank is allowed to have. Just because a swap is excused clearing and/or collateral posting, does it also get excluded from these limits? Probably not.

But the biggest question is, which swaps get to benefit? The working definition seems to be swaps associated with covered bonds that are compliant with the CRR definition of covered bonds. So no aircraft, SME covered bonds, no non-EEA originated covered bonds (to the extent that they are issued in the EEA), and certainly no ‘structured’ covered bonds. So, further strengthening of the difference between what is a real covered bond and what is a mere lookalike.

 
(I’m very grateful to Paloma Repullo of the European Mortgage Federation who has written an excellent summary of the EMIR consultation process in the latest edition of Mortgage Info magazine if you need more details.)

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