Thursday 30 March 2017

* HAIRCUTS IN SECURITIES FINANCING. ESMA



EU Regulation on Transparency of Securities Financing Transactions and of Reuse  aims at reducing financial stability risks . Within its development ESMA has published a research paper about  Trends, Risks and Vulnerabilities (on shadow banking)  We extract this paragraph related to descuentos (haircuts) in SFT 


"Securities financing transactions (SFTs), which include mainly repurchase agrements (repos) and securities lending, involve the temporary exchange of cash or securities against collateral. EU SFT markets are very large, with the value of collateral used in SFTs amounting to several trillions of euros. To cover for risks related to the characteristics of the collateral and counterparty creditworthiness, a discount known as a haircut is usually applied to the value of collateral. Haircuts are helpful risk management tools, but haircut levels are also part of the negotiation between counterparties trading bilaterally. Haircuts may thus change over time to reflect the evolution of market conditions, and can contribute to procyclicality and financial instability by reinforcing asset price movements. 

"Haircuts are often, but not systematically, used as a pricing mechanism following internal discussions between the credit (or risk) department and trading desks. In securities lending markets, some entities rely on haircut grids pre-determined internally, from which traders can deviate up to a certain percentage, but the tolerance band for such deviations depends on the characteristics of the collateral and the entity’s risk appetite.  Collateral and counterparty analysis are the two key components used to determine haircuts. Counterparty credit risk plays a role prior to the transaction, in deciding whether or not to trade, and during negotiation on the terms of the trade. Factors considered in the counterparty analysis include creditworthiness, exposures and concentration. Factors considered in the collateral analysis include historical volatility of the asset, residual maturity, market risk, wrongway risk, currency mismatch, and asset class (for tri-party repos). Other minor factors may also influence haircuts, including for example the type of collateral ownership (title transfer versus collateral pledge). Following the internal risk assessment, trading desks usually engage in negotiations with their counterparty, which often include haircuts. Haircuts are one of the price components, together with repo rates or securities lending fees, that traders may use to strike a deal."