British banks probed over adequacy of collateral from hedge funds

By Peter Thal Larsen
Financial Times, London
Sunday, December 3, 2006

http://news.yahoo.com/s/ft/20061203/bs_ft/fto120320061653056819

London's largest investment banks are to face a wide-ranging probe into their measurement and management of collateral amid concerns that some may not be properly prepared for a sudden market downturn.

The Financial Services Authority, the City watchdog, has launched an investigation into the banks' systems for measuring and managing the collateral they demand from hedge funds, banks, and other trading counterparties.

The move, which the FSA describes as "thematic work," is the latest stage of the regulator's attempt to identify areas that may pose a problem for the financial system during a crisis. Other regulators around the world are likely to pay close attention to the outcome of the investigation, which may involve co-operation with the US Federal Reserve.

FSA officials stressed that the probe was not triggered by any specific problems but reflects the growing importance of collateral in banks' management of their risks.

"Time after time we as supervisors hear the words, 'don't worry, its collateralised,'" Thomas Huertas, director of the wholesale firms division at the FSA, said in a speech last month. "Well, regulators do worry."

Banks generally demand collateral from clients as security for loans or margin trading on securities. It is widely used by banks' prime brokerage divisions, which handle relationships with hedge funds, but is also used in the bond market as well as the fast-growing equity and credit derivatives markets.

But growing competition for hedge fund clients has prompted some investment banks to relax the criteria demanded by their prime brokerage divisions, which lend money to hedge funds to support their trading strategies. Earlier this year Timothy Geithner, president of the Federal Reserve Bank of New York, highlighted the importance of collateral in banks' management of counterparty credit risk, particularly with hedge funds.

The collapse of Amaranth, which suffered heavy losses after betting on North American gas prices, has also highlighted the scope for sudden violent swings in assets held by hedge funds.

Mr. Huertas said the FSA would look at how banks value collateral and whether they can get it back quickly in a crisis. The regulator would also examine in what circumstances the collateral accepted by banks might be linked to the value of the bank's underlying exposure.

Mr. Huertas pointed out that collateral is often pledged across borders, can continue to be traded after it is pledged, and that banks which have received collateral from one institution increasingly pass it on to another institution. "Will all this work, and will it work in a stressed environment? That is the key question," he said.

* * *

Join GATA
at the
2007 Vancouver Resource Investment Conference
Vancouver Convention and Exhibition Centre
Sunday and Monday, January 21 and 22, 2007

http://www.cambridgeconferences.com/ch_jan2007.html

Admission is free for those who register in advance. The conference has arranged discount rates at the Pan Pacific Hotel adjacent to the convention center.

* * *

Help Keep GATA Going

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at http://www.GATA.org. GATA is grateful for financial contributions, which are federally tax-deductible in the United States.