Aussie parents of NZ's big banks fighting new international derivatives regulations they say will cost them hundreds of millions of dollars

Aussie parents of NZ's big banks fighting new international derivatives regulations they say will cost them hundreds of millions of dollars

By Gareth Vaughan

New Zealand's big banks are not currently involved in a "vigorous fight" against new international derivatives regulations their Australian parents maintain could add hundreds of millions of dollars to their funding costs.

The Australian Financial Review reports ANZ Banking Group, Commonwealth Bank of Australia, Macquarie Bank, National Australia Bank and Westpac Banking Corporation, have written a joint letter to the the International Organisation of  Securities Commissions (IOSCO) saying the Australian banking system would be “severely impacted” by a plan that aims to reduce systemic risk in the global financial system, which  was proposed by the Group of 20 and is being implemented by IOSCO.

The AFR report said;

Australian banks would need to pay a margin of 6 per cent on about $350 billion of cross currency swaps.

The swaps are used to hedge foreign exchange and interest rate risk for offshore transactions.

KPMG partner Craig Davis said Australian banks were extremely large users of cross currency swaps due to their offshore funding dependence and the issues highlighted unintended consequences stemming from the wave of new global financial regulation being implemented in response to the global financial crisis.

“This would be a massive funding impost on the banks and potentially cost them hundreds of millions dollars in extra funding costs,” Mr Davis said.

A Reserve Bank estimate puts New Zealand banks' combined outstanding cross currency swaps, used to convert money borrowed overseas into New Zealand dollars to help fund bank balance sheets and subsequently home loans and business loans, at about NZ$35 billion.

The AFR article also noted that;

The problem is unique to a handful of countries such as Australia and Canada, which are heavy users of cross currency swaps due to a shortage of deposits and reliance on international funding markets to fund their loan books.

And;

Australia’s major banks rely on international wholesale markets for about 25 per cent of their total annual funding.

Most of their offshore funding is swapped back into Australia dollars, through cross currency swaps, which hedge against fluctuations in the exchange rate and interest rates.

One senior banker, who declined to be named, said that each of the big four banks used between $70 billion to $100 billion in cross currency swaps on gross outstanding debt.

The issue is also on the agenda at New Zealand's major banks. However, a spokesman for the New Zealand Bankers' Association told interest.co.nz the bank lobby group hasn't been involved in the issue to date.

New Zealand's big banks source even more of their funding from international wholesale markets than their parents. Credit rating agency Moody's estimates the big four, on average, source 37% of their funding from wholesale - both short-term and long-term - sources, with this including money sourced from their Australian parents.

Reserve Bank 'interested'

In its most recent Financial Stability Report the Reserve Bank said it was interested in new arrangements for  the clearing of over-the-counter (OTC) derivative contracts. It noted that after a G20 commitment last year, jurisdictions with the biggest OTC derivatives markets - the European Union, United States and Japan - have mandated clearing of many derivative contracts through central counterparties beginning this year.

"The Reserve Bank sees the adoption of centralised clearing as a positive move towards managing risks from derivatives contracts. New Zealand banks have now firmed up, or are in the process of firming up, arrangements with broker agents through which they will participate indirectly in international central counterparties," the Reserve Bank said.

"The Reserve Bank will monitor and assess the financial stability implications of such arrangements, particularly where risks might arise from the concentration of clearing services being delivered by a small number of broker agents."

Following the 2008 collapse of Lehman Brothers the G20 made a commitment for derivatives trades to be transacted through central clearing parties in an attempt to reduce counter party risk. Leaders of G20 countries agreed at their Pittsburgh 2009 Summit that all standardised OTC derivative contracts be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties, that OTC derivative contracts be reported to trade repositories, and that non-centrally cleared contracts be subject to higher capital requirements.

A report recently prepared for G20 ministers and central bank governors said although considerable progress had been made, much was still to be done to complete agreed reforms.

"While progress has been made toward meeting the G20 commitments, through international policy development, adoption of legislation and regulation, and expansion of infrastructure, no jurisdiction had fully implemented requirements by end-2012. Less than half of the Financial Stability Board member jurisdictions currently have legislative and regulatory frameworks in place to implement the G20 commitments and there remains significant scope for increases in trade reporting, central clearing, and exchange and electronic platform trading in global OTC derivatives markets," the report said.

NZ-Aussie dialogue through CER

David Love, director of policy & international affairs at the Australian Financial Markets Association (AFMA), told interest.co.nz it's widely accepted that the global regulatory reforms will increase financial intermediation costs.

"However, there is particular concern in this instance that the proposed initial margin requirements on non-centrally cleared derivatives trades would have a disproportionate impact on the Australian OTC derivatives market, because of our reliance on overseas capital and the associated high proportion of cross currency swaps carried out in our market," said Love.

“AFMA and our affected members are in continuing dialogue with the Australian regulators about this issue and representing our industry views to the Basel Committee on Banking Supervision-IOSCO Working Group.”

Love said the respective regulators and government departments of Australia and New Zealand have a regular dialogue under the Closer Economic Relations agreement to discuss financial sector issues of common concern,  including the impact of global regulation and principles.

This article was first published in our email for paid subscribers. See here for more details and to subscribe.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

37 Comments

Comment Filter

Highlight new comments in the last hr(s).

Australian banks would need to pay a margin of 6 per cent on about $350 billion of cross currency swaps.
 
New Zealand's big banks source even more of their funding from international wholesale markets than their parents. Credit rating agency Moody's estimates the big four, on average, source 37% of their funding from wholesale - both short-term and long-term - sources, with this including money sourced from their Australian parents.
 
Hmmm - why are New Zealand depositors so sanguine about their deliberately OBR imposed notional swap counterparty exposure in the event of a bank being declared insolvent? 
 
ANZ New Zealand Limited posted NZD 820,538 millions notional derivative positions for the year ending 30/9/2012, compared with NZD 954,793 millions the year before - A 6% margin collateral call would amount to ~NZD 49,232 millions - How can NZ depositors be expected to liquidate this potential risk liability if the bank's parent is disputing the lesser cost in Australia for lesser amounts?
 
I made these comment back on 30 Apr 13, 9:19am in a comment to another article written by Gareth
 
My comment, as of  25 Apr 13, 9:08am, garnered little response from those charged with the responsibility of maintaining the health of the nation's unsecured deposit base. 
 
Here we go again, just as a reminder: 
In view of the pending introduction of OBR could ANZ enlighten the depositor funding backbone of the curious but as yet unexplained risks associated with the derivative positions set out in Note 11 document pages 25 -26 in the the last annual disclose statement.
 
Notably, Deutsche Bank has just announced a $72.8 trillion notional derivatives exposure.
 
And as yet not much of an explantion from them either. 
 
But the comment from this ZH article captures the denied risk:
 
The good news for Deutsche Bank's accountants and shareholders, and for Germany's spinmasters, is that through the magic of netting, this number collapses into €776.7 billion in positive market value exposure (assets), and €756.4 billion in negative market value exposure (liabilities), both of which are the single largest asset and liability line item in the firm's €2 trillion balance sheet mind you, and subsequently collapses even further into a "tidy little package" number of just €20.3. 
 
Of course, this works in theory, however in practice the theory falls apart the second there is discontinuity in the collateral chain as we have shown repeatedly in thh past, and not only does the €20.3 billion number promptly cease to represent anything real, but the netted derivative exposure even promptlier become the gross number, somewhere north of $70 trillion.
 
Which, of course, is the primary reason why Germany, theatrically kicking and screaming for the past four years, has done everything in its power, even "yielding" to the ECB, to make sure there is no domino-like collapse of European banks, which would most certainly precipitate just the kind of collateral chain breakage and net-to-gross conversion that is what causes Anshu Jain, and every other bank CEO, to wake up drenched in sweat every night.

Stephen, I haven't seen anything suggesting a bank's entire notional derivative position would be hit with the 6% margin.

The point is that the RBNZ see fx derivatives as "risk free". They are deluded.

Gareth do you have an explanation that sets interest rate swaps etc apart from currency swaps in terms of counterparty risk, and the risks generally applicable to each swap category?

I guess a local cross currency swap book would expand a tad financing this development.
 
Smith told the committee it was "offensive" that an investor could buy a block of dirt for $890,000 in 1995 and put it on the market today for $112 million. Read more
 
 
Political risk unintended or otherwise places all interested parties at risk. 

Stephen Hulme: There are 2 issues arising from your post. They arose in your original post. They're still there. They haven't gone away.
 
1. Transparency. Absent. Doesn't exist. MIA. Rule by Opacity. Or is it the Rule of Opacity
 
2. Joe Public, that "man in the street" wouldn't have a clue what you are talking about, and until they do, until they understand (a) what it is you are talking about, and therefore (b) the implications of what you are talking about, no groundswell of opinion will ever rise up against it.
 
In the meantime "they", the banksters, the reservists, the cogniescenti, the officials, the treasurians, the parliamentarians will all continue to dream up alphabet soup in the knowledge they can sleep easy while the mushrooms remain un-informed, (ill-informed) living in the dark.
 
If you want response, the challenge for you is to re-write your article so Joe Public understands it in terms he can relate to.
 

Never happen iconoclast...peasant mushrooms are easier to pluck!
Rule of thumb here: keep cash savings very short term at worst...in the hole under the floor at best...but beware of the rapid move to renew the paper to force savers back to the banks.
The OBR will murder those who believed they have been told the truth.
If cash savings are large...then head to property....buy in the downs....hold/rent and then sell in the ups...avoid the CGTaxes as the pollies have been doing for decades.
There will be a storm of lies now in the 'idiots media' about why banks in NZ are ever so safe and why keeping cash at home is awfully dangerous.

Yes iconoclast , but the whole point of derivatives is to be convoluted...and difficult to see through to the layperson....or even reasonably qualified...then on to economists.
I added my ten cents worth to the original article citing exactly the unmesured levels of  exposure with the big four susiduaries. The question that also remains unanswered is the Continuing Bank principle, whereby in crisis the Minister may determine what should be considered secured monies.
 What we do now know, from an earlier post I put up is that the Australian parent bank is entitled to place deposit holders in Australia ahead of their N.Z. counterparts, should exposure levels cause them to require the funds, the N.Z. dp holder will forfeit first....now combine that with OBR..and I'd say it would suck to be a deposit holder with any of the big Four...BTW includes all foreign curreny also. 
 
The problem getting Joe Public to understand anything is usually a retrospective exercise, ...hold this...ow , WTF..that burns...great now I explain why and hope it doesn't happen again.
 The fact the collective is writing a whinge letter is transparent enough for people to be concerned that they ( the greedy  Bastards ) are nervous...to say the least.

Transparency
 
The annual GDP of New Zealand is $350 billion, or
$1 Billion per calendar day, or
A bit under $2 billion per trading business day
 
Yet the currency merchants are transacting through New Zealand
$50 billion per day every day
That's $1,750 billion a year
That's $1.75 trillion a year

nobody knows where it's going
nobody knows what it's doing
nobody knows what it's used for
nobody knows who is doing it

And while people dont know, they can't care and won't care
 

News for you Kimy. Outright currency trading is done on a 1:1 basis
You want leverage of 400:1 you are trading derivatives against a market-maker

Iconoclast - your NZ GDP number is almost 100% out - its closer to $200bln than $359bln. Do currency volumes matter that much - most of it is interbank trading etc - the more liquidity in a currency, and smaller spread accordingly, then all the better.

Grant A: Do they matter?. How can one answer that if they don't know. Can't can they?
 
I read somewhere GDP was $350 bn. It is relevent to an article last week by Matt Nolan who argued against a Financial Transaction Tax because it would affect export revenue. Well, annual export revenue is a part of GDP, and less than total GDP. And a great deal less than $1.75 trillion. There are a number of mechanisms to offset that. My main point stands. The total amount of annual currency streams flooding through (into) new zealand are huge, and are not explained simply by inter-bank transfers. Sure inter-bank transfers come through the banking system, and contained in inter-bank transfers to get here. But the questions I pose still stand - what are they. It's not ALL exports which ARE currency inflows. It's not imports or purchase of imported capital goods which are outflows. It's not mortgage rollovers using overseas wholesale funding which may be inflows. Total outstanding Mortgages are $192 billion, of which only 37% is O/S wholesale funding, and they dont all rollover every year. And rollovers are netted off in the country of origin, and don't actually produce an inflow. What is it?

iconoclast - you are not wrong. Read about the latest investigation that's apparently about to get underway.
 
Banks Rig $4.7 Trillion A Day Currency Markets To Profit Off Clients
 
The world’s biggest banks have been manipulating benchmark foreign-exchange rates used to set the value of trillions of dollars of investments, according to a Bloomberg investigation.
 
Employees have been front-running client orders and rigging WM/Reuters rates by pushing through trades before and during the 60-second windows when the benchmarks are set, said five current and former traders, who requested anonymity because the practice is controversial. 
 
Dealers colluded with counterparts to boost chances of moving the rates, said two of the people, who worked in the industry for a total of more than 20 years.

Did I get the numbers wrong? If so please correct me so I get it right next time. And there will be a next time.

If it moves - tax it, I say.
 
Surely the NZD would soon stop being the puppet on a string that it is.

FTT's....John Key..?.Kate, he'd rather sell his children than break the creedo of a money trader.

" this is what happens when bubbles burst"
 http://globaleconomicanalysis.blogspot.com/#WVM72VtPzJPIq83X.99

Jeremy Grantham said there was some money to be made in emerging markets as they were less of a bubble. He seemed to be saying 18months or so of gambling....maybe his timing is impecable.
His april letter,
http://www.gmo.com/websitecontent/GMO_QtlyLetter_1Q2013.pdf
"The Fall of Civilizations
The collapse of civilizations is a gripping and resonant topic for many of us and one that has attracted many scholars
over the years. They see many possible contributing factors to the collapse of previous civilizations, the evidence
pieced together shard by shard from civilizations that often left few records. But some themes reoccur in the scholars’
work: geographic locations that had misfortune in the availability of useful animal and vegetable life, soil, water, and
a source of energy; mismanagement in the overuse and depletion of resources, especially forests, soil, and water; the
lack of a safety margin or storage against inevitable droughts and famines; overexpansion and costly unnecessary
wars; sometimes a failure of moral spirit as the pioneering toughness and willingness to sacrifice gave way to softer
and more cynical ways; increasing complexity of a growing empire that became by degree too expensive in human
costs and in the use of limited resources to justify the effort, until the taxes and other demands on ordinary citizens
became unbearable, so that an empire, pushed beyond sustainable limits, became vulnerable to even modest shocks
that could in earlier days have been easily withstood. Probably the greatest agreement among scholars, though, is that
the failing civilizations suffered from growing hubris and overconfidence: the belief that their capabilities after many
earlier tests would always rise to the occasion and that growing signs of weakness could be ignored as pessimistic.
After all, after 200 or even 500 years, many other dangers had been warned of yet always they had persevered. Until
finally they did not."
regards

if the banks aren't hobbled, someone else will suffer. That's what happens under a sinking lid. The banks should indeed be the ones to be shut down - completely, in the end - because their activity is 100% parasitic, and the need to expand 'money' was only there in the growth phase. Any tighteneing of eregulations will always lag the shifting of the goalposts, so they'll still be ahead.
 
It's only 'costing' them in the sense that they'd have creamed more if the regulation wasn't tightened, and we have to remember that the stuff they rent to us, was created for free.
 
What would house prices be without banks and usury, Gareth? (and what would be the new name for this site  :) I suggest the median multiple could not go above 1:1 - suggesting Hughey's chasing the wrong stick.

More on this in the AFR today;
"Australian Securities and Investments Commission chairman Greg Medcraft has personally intervened to seek relief for Australian banks from a new global derivatives regulation that threatens to add hundreds of millions of dollars to their funding costs.
Mr Medcraft, the chairman of the International Organisation of Securities Commissions, attended a meeting in Petersburg, Russia last week. He is negotiating with international peers for Australia to be largely exempt from paying an upfront margin on uncleared derivatives such as cross currency swaps...
A spokesman for ASIC said the ­regulator recognised the concerns of the local finance industry and it would be discussed in Montreal on June 18 and 19...
Triple T Consulting managing director Sean Keane said the income loss for the major banks would be about $250 million a year, assuming an upfront margin of 6 per cent and 120 basis points in forgone of investing the margin in overnight cash.
Clearly such a margin would cost the banks potentially significant amounts in terms of foregone interest income, he said."
http://www.afr.com/p/business/financial_services/asic_backs_banks_on_glo...

The sheer irony of it Gareth. You gotta smile. Makes ya want to cry. ASIC have the time and resources to scuttle off to Russia to argue the case for the Banks. You gotta wonder if it's a quid-pro-quo paid for by CBA for services rendered. See the 2nd and 4th articles by Michael West http://www.theage.com.au/business/by/michael-west who's looking out for who?

These are the types of sociopaths to which we have extended a free capital pass by introducing a retail deposit capital reconstruction fund commonly known as OBR in the highly likely event one or all of the Austalian owned NZ banks enters a state of  insolvency, declared or otherwise.

I dont understand what you are driving at here.  The OBR isolates the lending and deposit part of the bank's business from the chequing account. 
To me that means,
a) As a tax payer I and my children less likely to be lumbered aka Ireland as the NZ Govn is not forced to step in and support.
b) The bank over in OZ then has to let the NZ arm fold, or pump in money, though frankly if the NZ branch is that much of a basket case so will the OZ bank be I strongly suspect....and all of us will be freaking out.
c) If the OZ bank goes belly up the NZ branch can carry on trading...that is my understanding of how the NZRB has insisted things are to be.
Of course if you are a depositor then you have no were to go. I am to but I'd rather face a loss of some of that than not have a OBR and the implications of that.
regards

If I understand Stephen correctly, the OBR assumes there will be sufficient cash deposits and reserves to meet any deficiency, to freeze some and use some to meet the deficiency via the OBR. What Stephen is saying is the exposure of the banks to derivatives are so huge, no-one knows how big they are, including the RBNZ, the banks are not disclosing, and the derivative exposure is not included in the OBR, in other words making the OBR potentially meaningless. Nothing to freeze. All gone.

You got it iconoclast - just making a proposed regulatory 6% initial margin call payment on ANZ's stated derivative book would absorb 76.24% of the declared NZD 64,575 millions deposit base - see note 21 in my original link to ANZ's DS above.

Just to clarify folks, swap agreements & other derivatives wouldn't be exempt from the Open Bank Resolution process, per se. All liabilities that are not "pre-positioned" would remain frozen in full until the bank statutory manager has had the chance to process the haircut and release the "good" portion.
I included a table in this story (link below) that shows what would & wouldn't be "pre-positioned" under OBR. If something's not pre-positioned that means it would remain frozen in full at the behest of the bank's statutory manager.
http://www.interest.co.nz/kiwisaver/64001/kiwisaver-funds-held-banks-won...

Gareth, you cannot freeze collateralised currency swaps - chances are the foreign lender has already got the foreign funding back through the currency swap - Others will be margin called up with mark to market collateral calls prior to collapse - I have been there and seen it with my own eyes.

The Give Way principle invoked by the Dominant.....under OBR , Gareth, we have nothing but give way rule to observe. The freeze will just be the traffic jam while your gas gets siphoned.

Stephen, the OBR doesn't set out that deposits will be syphoned off to make good a bank's derivative positions. That's the point I'm making. What happens before the OBR is applied to a troubled bank, if it's applied, is another matter.

Gareth - I am not making that claim - writing off the insolvent asset side of the ledger will easily absorb the so-called eligible pre-positioned unsecured creditors, including deposits - the total retail deposit base is a miniscule ~NZD115 billion.- The assets are? - magnitudes greater? - but funded off balance sheet by swap related borrowing. How do the receivers write off the $KIwi lent by our banks to a foreign borrower who passes it back as swap collateral to the same NZ bank, which can squander it with poor lending practices?

You have clarified your position for me nicely Stephen, cheers. In terms of the OBR, I still doubt we'd see it used if a major bank fell over. A government bailout's more likely.

Thanks, not that I feel much safer.
 
What I find indefensible is the RBNZ's largely unannounced introduction of the OBR policy while there are deliberately unattended lapses in regulatory control/management of banks' off-balance sheet funding actions.  
 
 

Gareth Vaughan: A perfect example of what Stephen Hulme is saying was played out 12 months ago with the bankruptcy of MF Global Australia. The adminstrators and liquidators took control of the company on the Monday and froze everything. Cash holding accounts. Margin accounts. And all open positions. No-one could trade. No-one could close open positions. In the meantime over the following months, until the liquidators pulled their finger out, the underlying assets continued to move, for many adversely. And so it was. When the liquidator finally closed out all exposures, the picture wasn't pretty.

Yup he's got it Stephen H...now it's just quite what one can do about it.
 Grabbing a Mask and joining the 99 is getting passe, ya gotta hit em where it hurts , and unfortunately , where it hurts , hurts the innocent...also.

Oh BTW.Gareth...great article, can't wait for the next instalment....thanks.