In a release last week, the International Swaps and Derivatives Association has determined that collateral in circulation has essentially doubled from its 2008 estimate of $2.1 Trillion to $4 Trillion. Not surprisingly most of this collateral is in cash.
Cash continues to grow in importance among most firms, and now stands at over 84 percent of collateral received and 83 percent of collateral delivered.
“Recent market events underscore the importance of collateralization as a risk mitigation tool,” said Robert Pickel, Executive Director and Chief Executive Officer, ISDA. “ISDA’s 2009 Margin Survey indicates that, amidst the volatility in the financial markets, collateral management programs continue to expand, covering increased trade volumes and credit exposures.”
The 2009 Survey reports that collateral agreements in place now number over 150,000. Among firms that responded both in 2008 and 2009, collateral agreements grew by nine percent. Respondents forecast further growth of 26 percent during 2009. This reflects a long-term trend toward increased collateral coverage.
Additionally more than half of the respondents stated that they engage in some form of systematic portfolio reconciliation, many on a daily basis. Portfolio reconciliation is the process by which market participants verify the existence and salient details of outstanding trades.
This significant sum not only can be used to estimate net exposure from derivatives (although it is unclear if this accounts mostly for CDS contracts or all swaps), but also to indicate the dramatic drop of leverage used to position derivative exposure. As DTCC discloses that gross CDS notional has declined from roughly $65 trillion to less than half, and stood at a tad over $28 trillion in the last week, while collateral has doubled into this number, the contraction in leverage used for CDS and other derivatives is likely material.
Another interesting tangent is where all this money is invested, with Treasuries (especially one month and other near maturities) likely being an easy conclusion. Any endogenous risk events will likely have a shakeout not only in the derivative collateral market but also in their downstream investment, and could potentially be yet another shock to treasury holdings, especially if a wholesale unwind forces the accelerated sale of Tsys by collateral counterparties. Inevitably, market optimists will say all possible black swans have been successfully priced in in perpetuity at this point, although remarks like the one today from the ever evasive Sheila Bair may present a contrarian view:
The FDIC’s resolution powers are extremely effective when a smaller bank fails. But they fall short when it comes to very large financial organizations. Why? The main problem is that we don’t have the ability to resolve bank holding companies. We can only resolve the insured depository institution within the holding company.
Although this shouldn’t be a problem: the dynamic duo of Bernanke and Geithner will simply hold a corner conversation behing closed doors to convince any BHC CEO not to default and that will be that.
Originally published at the Zero Hedge blog and reproduced here with the author’s permission.