UPDATE 1-EU watchdog to monitor any collateral squeeze from new rules

Thu Feb 14, 2013 10:44am GMT

By Huw Jones

LONDON Feb 14 (Reuters) - The European Union's markets watchdog will monitor the use of collateral as tough rules forcing banks to hold more in order to make derivatives markets safer are prompting some lenders to warn there may not be enough quality holdings to go around.

Collateral refers to cash and assets such as government bonds which parties to a derivatives trade post as security. The aim of the reforms is to avoid another situation like that when derivatives-laden Lehman Brothers crashed in September 2008 with little visibility about how far their debts would impact others.

"In view of the potential financial stability risks linked to relative collateral scarcity, the availability and use of collateral needs to be monitored," said the European Securities and Markets Authority in its first report on trends, risks and vulnerabilities in the 27-country bloc's markets.

"The availability of collateral will thus remain a concern for a while," it said.

However ESMA estimated that the supply of higher-quality collateral was estimated at 11.8 trillion euros in Europe last year, against demand at 4.1 trillion euros - weakening some claims from industry that a collateral crunch is looming.

The International Swaps and Derivatives Association, a trade body, has said regulators may be "overshooting and creating a collateral crunch" with the new, tougher derivatives rules.

ESMA estimates that Europe will need an extra 2.44 trillion euros in collateral for 2014 as a result of the new regulations, and that supply will rise by 0.85 trillion euros between end 2012 and 2014.

But the supply of collateral would still be 6.1 trillion euros higher than demand in 2014, ESMA estimated.

However, ESMA did acknowledge that demand is "ramping up" and that could push up the price of high-quality assets and market participants would turn to using lower-quality assets such as shares or exchange-traded-funds, it said.

Global regulators said on Wednesday they are taking more time to finalise the derivatives rules, partly because of concerns over collateral supply.

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