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If the change is voted through as it stands, which could happen in July, the Bundesrepublik Deutschland Finanzagentur – known to market participants as the Bund - would be the latest in a series of European debt offices to change policy, and by far the most significant. As of end-2012, the Finanzagentur had a swaps portfolio with a notional value of roughly €300 billion, making it one of the world's biggest sovereign derivatives users.
"This is a huge deal. It could change the landscape", says one head of rates trading at a European bank in London. "If the best credit in the eurozone decides to collateralise, it sets a clear precedent and paves the way for others to follow. If the Bund does it, there is no reason why other sovereigns, supra-nationals and agencies (SSAs) would not follow."
The move is dependent on the German finance ministry's 2014 budget proposal being passed in its current form. The 3,358-page proposed law states that the German finance ministry will be authorised to borrow up to €8 billion to fund collateral posting on interest rate swaps specifically – the ceiling is set at 10 per cent of the total volume of new rate swaps the Finanzagentur is allowed to execute. Currently, funds raised by the Finanzagentur could not be used for collateral posting – some German states have also had to change their laws to permit the posting of collateral.The Finanzagentur declined to say whether it would start posting collateral if the law was passed. A spokesperson for the debt office said it would only comment following a final decision on the budget, which could happen in July, after a second debate in Germany's Bundesrat – one of the country's two legislative chambers.
It is not known whether the proposed rule change originated from the finance ministry or the Bund, but a source close to the ministry says the Finanzagentur called for the change in order to lower its hedging costs – the same rationale cited by the Bank of England when it announced it would sign two-way credit support annexes (CSAs) in June 2012. Market participants say the debt office is also planning to start centrally clearing its swaps – in Europe, only the Swedish debt office currently does so.
A one-way CSA has an added complication in that if the dealer had hedged its trade with the sovereign by conducting an offsetting trade under the terms of a two-way CSA, then it would not receive any collateral from the sovereign when the value of the first trade is in its favour, but would be required to post collateral to its hedge counterparty, creating a funding obligation.
Many dealers now charge for this obligation – the so-called funding valuation adjustment (FVA), which is causing consternation among some SSA derivatives users. Dealers – non-European at least – also face significant capital costs on uncollateralised exposures with sovereigns as a result of the new Basel III charge for credit valuation adjustment (CVA). One of the key inputs to the charge is the exposure the bank has to the counterparty, which can be significantly reduced by the posting of collateral. Europe's version of Basel III excludes trades with sovereigns from the CVA charge
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