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April 2, 2014

Wall Street in derivatives spring clean to buoy capital

“In an unusual example of co-operation on Wall Street, the biggest banks are working together to tear up billions of dollars worth of derivatives trades as they seek to reduce their use of precious regulatory capital.

“Financial reform in recent years has focused on making the trading of derivatives safer by mutualising credit risk through centralised clearing houses. While that takes care of new trades, the major dealer-banks that dominate the derivatives industry have vast books of old positions that are eating up their capital under new rules.

“As new swaps are centrally cleared, so the industry is accelerating a push to get rid of old trades, in an effort that is seen reducing overall systemic risk within the financial system. In particular the leverage ratio, which measures bank capital against all of their assets, is making it more expensive for big banks to hold on to derivatives.

“The leverage ratio has catalysed people to do more compression trades,” said Satyajit Das, a former banker-turned author. “Suddenly there is an incentive to compress trades as it makes your use of capital more efficient.”


Read full Financial Times article here.

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