Bloomberg News

European Banks Insure $25 Billion of Government Debt via Swaps

December 16, 2011

Dec. 16 (Bloomberg) -- European banks have sold insurance on a net 18.9 billion euros ($25 billion) of government debt in the region, according to figures from the European Banking Authority analyzed in today’s Bloomberg Risk newsletter.

Data gathered by the EBA for its stress tests, combined with figures compiled by the Depository Trust & Clearing Corp., show that European Union banks are responsible for 17 percent of the credit-default swaps issued on euro sovereign bonds.

German, French and Italian banks have the most at stake, the data show. German banks have underwritten 8.1 billion euros of government securities, the most for any country surveyed by the EBA. The four largest French banks, which were downgraded by Moody’s Investors Service last week, wrote 4.1 billion euros of protection, while Italian banks sold 3 billion euros of swaps designed to compensate the buyer in the event of a government failing to meet its obligations.

The entanglement between banks and their governments may hamper plans by regulators to move settlement of credit-default swap trades to clearing houses by the end of 2012, said Jon Gregory, partner at Solum Financial Partners in London. French banks, for example, have insured a net 1.5 billion euros of their own government debt, according to the EBA.

Risk Analysis

“Managing portfolio and wrong-way risks in credit-default swaps is one of the most difficult challenges on a technical level, and it is unclear that clearing companies have had the time or expertise in place to manage this properly,” said Gregory. “In terms of disclosure, clearers are a bit of a black box in terms of analyzing the risk on their balance sheets.”

The only clearing house that can currently handle sovereign default swaps is InterContinental Exchange Inc., which began clearing Brazilian, Mexican, Argentine and Venezuelan CDS last month. In its Securities and Exchange Commission approval for the move on Oct. 18, ICE Clear Credit said it would prohibit dealers from clearing CDS on their own countries because the default correlation risk was too high.

ICE is still awaiting Financial Services Authority approval to clear European sovereigns, fifteen months after submitting a request for approval. Rival LCH.Clearnet Ltd. is focusing on clearing corporate single-name CDS, according to an e-mailed statement from the company.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. The figures for Europe’s banks are net positions; German banks, for example, have sold 109 billion euros of protection and bought 100.9 billion euros.

--Editors: Mark Gilbert, Andrew Rummer

To contact the reporter on this story: Radi Khasawneh in London at rkhasawneh1@bloomberg.net

To contact the editor responsible for this story: Nicholas Dunbar at ndunbar1@bloomberg.net


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