Buy side chafes at collateral demands

A common complaint by buy-side traders speaking at the FX Invest Europe congress in Zurich last Tuesday was the prohibitively high collateral requirements set by the sell side in the past six months.

Speakers said that collateral demands for currency forwards have jumped to 10% following the collapse of Lehman Brothers in September, versus exchange-traded products, where it is around 3.5-4%.

Gulamabbas Lakha, chief executive and chief investment officer at London-based Providentia Capital said that, since September, buy-side traders have not only had to contend with increased political and correlation risks but also a doubling of collateral requirements from the sell side. As a result, Lakha said, implementation of portfolio construction has increasingly shifted from expensive over-the-counter products to cheaper exchange-traded products.

He continued that the perception of counterparty risk as an investor has also changed since the collapse of Lehman Brothers. "Even at a segregated account level it can take around six months to get your money out," he added. "So we're seeing more rebalancing of implementation tools from OTC counterparties to exchange-traded."

Michel Girardin, chief investment advisor at Union Bancaire Privee (UBP), agreed, adding that the Swiss private bank is moving away from using cash intensive currency forwards to a more options-based hedging strategy. Girardin also said that UBP has shifted away from a systematic hedging strategy for its fund of funds, to tactical overlay hedging.

However, the sell-side banks on the panel pointed out that there is less flexibility in exchange-traded products and, in this environment, particularly when it comes to margin calls. Ed Pla, global head of foreign exchange prime brokerage at UBS noted that, if a trade goes wrong and the bank puts in a collateral call with a client, it might not see the margin for days, if not a week, depending on the agreement. "Whereas as an exchange will harass you to get the margin in as soon as possible," he said.

Jeremy Armitage, senior managing director and head of global research at State Street Bank and Trust, agreed, adding that the interbank market is still where price discovery is. But, he admitted, interbank credit risk is still a problem and exchange trading does offer clearing and settlement benefits.

Saima Farooqi, Editor

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