If ever there was a topic guaranteed to cause disgruntled murmurings among the otherwise genteel SSA banking world, it was that of two-way credit support annexes governing the derivatives rules of engagement between issuers and dealers — or, more precisely, the lack of them.
The cost to banks of asymmetrical relationships with their SSA clients, where the bank would have to post collateral if a swap position was out of the money but the issuer would not if it was in the money, had always been swallowed in order to get to the sweet taste of prestige that being a big player in the public sector markets offered and the bond fees that went with it.
That changed in November 2012, when UBS shut its SSA DCM business overnight. The rising cost of capital in the post-crisis, regulation heavy era factors had suddenly made the costs of running an SSA business too unpalatable.
But the scenery in the SSA market has changed again.
More and more issuers have signed up to two-way CSAs and others have told GlobalCapital privately that they expect to put pen to paper over the next year. Those that are still holding out will soon have the weight of critical mass against them, and will find ever fewer firms with which to conduct cost effective interest rate and currency hedging — a practice they cannot avoid.
That changes the game for the SSA business. Sure, a lot of the other cost of capital concerns are still present — not least the cost of supporting secondary trading.
But with the two-way CSA question looking ever more certain to be resolved in the banks’ favour, a major obstacle to turning a profit from public sector dealerships is slowly fading from view.
And the opportunities for banks that want to return or enter for the first time are great.
Many SSA issuers are unconcerned about the possibility of lower liquidity — they feel that the market will find a way through it, and as one primary dealer reduces their secondary capabilities then another will take its place. More competition can only make that process more fluid.
Some might argue that there would be a squeeze on returns given the extra players involved, but that could be countered by banks finding specific niches with specific borrowers or issuer types. Already, as banks have been forced to retreat from universal banking business models, we have seen a shift into lead managers earning their place through the value they can add to a deal rather than a blanket approach to covering the entire SSA universe on both buy and sell sides
Issuers have understandably told GlobalCapital that extra competition is a good thing. That means that even those that left the business over the last few years could — far from struggling to rebuild broken relationships — find themselves welcomed home like the prodigal underwriters.
Issuers have changed their approach and, like the CSAs, the rewards from being present in the SSA market will go both ways.