The VM deadline, XVA on options and a resolution loophole

VM DEADLINE causing forex swap uncertainty

XVA a problem for options pricing

RESOLUTION DIRECTIVE too rigid on state aid, regulators say

COMMENTARY: The art of the possible

The EU’s Bank Recovery and Resolution Directive (BRRD) has hit rough ground again, with the realisation that political circumstances will make it very difficult for state aid to be restricted as much as the directive’s authors would like. In particular, regulators in countries covered by the BRRD say its requirement for 8% bail-in of total liabilities before state support can be given is too harsh. The bail-in requirement has caused problems before, and since news broke that Italian bank Monte dei Paschi di Siena was struggling, attention has turned to loopholes allowing states to circumvent this requirement if macroeconomic stability could be in danger.

But fears are not just confined to systemic risk. The bail-in requirement, for many banks, could force them to eat into retail deposits before becoming eligible for state aid, which politically speaking, could be a catastrophe – even a relatively mild bail-in for large depositors in Cypriot banks in 2013 caused ructions. And though resolution chief Elke König has called on banks to ensure they have at least 8% in “bail-inable” liabilities well in advance, this may not even be practical on a system-wide scale – especially if retail investors are also to be protected.

One way to square the circle was suggested late last month in the form of a ‘bad bank’ asset management company, created to ease the pressure on struggling but solvent banks. The danger here, if the measure becomes permanent, is of course moral hazard – there’s little incentive for inept banks to improve underwriting standards and build up bail-in reserves if they know the lengths to which governments will go to save them. Making it clear that the ‘bad bank’ plan, backed by the EBA’s Andrea Enria, is a one-off clear-out exercise rather than a permanent backstop would help – to an extent. Ultimately, though, as one resolution official observed, “If it’s 300,000 people [involved in a bank failure], it becomes a political interest, and it is very difficult for a political leader to ignore.” Retail deposits and financial stability are, rightly, untouchable: the challenge for national and European regulators must be to prevent them becoming human shields for the continent’s sloppiest banks.

STAT OF THE WEEK

European Parliament reforms aimed at cutting carbon credit supply could trigger much higher European allowance (EUA) prices over the next five to eight years, with analysts forecasting EUAs rising as high as €25 a tonne by 2025 from a current price of around €5/tonne.

QUOTE OF THE WEEK

“I think it’s going to be an issue that the [Financial Stability Board draft guidance paper] contemplates passing along non-default losses to clearing participants under any circumstances. It is positive that the paper emphasises using dedicated CCP resources and even equity to cover the non-default losses as a first order of defence, but I expect it will be problematic to even contemplate passing those losses on to clearing participants” – Ann Battle, Isda