TRS webinar: capacity, compliance and clearing are major themes

A Finadium webinar on Total Return Swaps (TRS) in December 2021 showed what market experts expect for 2022, following the exceptional multi-billion dollar fallout of Archegos. Here’s what we learned.

The size of losses related to Archegos, at some $10 billion across key banks, some of which are long-term players in prime brokerage, have not been ignored by the industry, boards, and regulators. And the failure was at many levels: the product itself, risk processes, and client transparency. While the event was not systemic, it brought to light how large TRS-related losses can grow, and was followed by Credit Suisse’s shuttering of its prime brokerage business.

Despite this ignominious retreat, Finadium’s panelists believe that prime and synthetic prime continues to be a sought after business. BNP Paribas is a clear contender to move in, and Barclays too has thrown its hat in the ring. But is this new capacity or just rearranging the deck chairs of the big players?

One panelist noted that between the top US and European banks, at least for now, there is differentiation. BNP Paribas, for example, is bringing a “significant capital footprint and intent”, said one panelist, as well as a full service offering boosted by the integration of Deutsche Bank’s prime brokerage and electronic execution business.

Hedge funds meanwhile continue to show interest in accessing a wider variety of derivatives, with prime brokers expected to be knowledgeable across the full range of financing avenues, including TRS along with securities borrowing and lending, repo, and cash prime brokerage.

Beyond Archegos

The focus on compliance and risk management goes beyond Archegos however, and is part of a larger global industry trend that includes collateral integration as “a proactive way to manage business”, said a panelist. This is happening against the backdrop of increasing regulation and reporting standards, with uncleared margin rules (UMR), which will bring in 1,000+ more participants under scope in September 2022, and SA-CCR calculation requirements being highlighted as particularly relevant. And just last week, UK regulators said they will require equity finance divisions at banks to conduct a systematic risk review and address failings.

The unfortunate events of Archegos combined with uncleared margin regulation and other regulations is driving the interest for a cleared product, something Turquoise Nylon has been working on for a while now. It’s expected to launch ahead of UMR’s last phase as a GCM model initially in UK, Europe and US, with a sponsored model and Asia to follow. Because the buyside will be tapping clearing members, there is likely to initially be a “stickiness”, with clearing and execution services bundled in a package.

Cleared swaps mean there will be two layers of transparency. For one, the clearinghouse will be able to see firms’ net position and open interest. And then the matching venue would have a much more granular set of data that can identify individual positions across multiple clearers.

How facilities such as triparty might fit in got a mixed review. Risk management will be improved because of the “safety factor” associated with collateral being held away from the counterparty. But whether triparty is the fastest route to getting more visibility remains a question mark.

TRS transparency 

Considerations around transparency are particularly urgent because regulators are moving forward with demands on short sales transparency, and there are indications that at some point TRS is going to end up in the mix. In the beginning, regulators are likely to tap banks and brokers to get the information: just around the corner in Febuary 2022, DTCC’s trade repository will be making SBSDR information public. However, a panelist noted that while TR data is useful for regulators, other groups will be required to put the pieces together for industry benefit.

While there is a certain amount of cynicism expressed over how data collection efforts will play out, to a large extent short sale data alone is not considered adequate to understand market exposures and participants want greater transparency across a range of products.

The end game, said one panelist, is going to go beyond compliance, and the focus may also become pre-trade analytics, for example to calculate how UMR charge impacts the success of a strategy. Moreover, regulatory reporting is going to give rise to not just transparency, but also audit and data lineage.

“Typically, what is happening when there is a new regulation, a new framework, you see a first wave of firms just trying to check the box and be compliant, but very quickly there is a trend of strategic thinkers trying to actually make the most of it,” a panelist said. “We can expect people asking for ways to optimize between uncleared and cleared world(s).”

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