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Arguably the Berlusconi news was a positive, but it’s clearly being overshadowed by the news that LCH.clearnet has increased the required collateral to trade Italian bonds.Here’s Citi on the matter:
LCH Clearnet increase overnight the amount of collateral to be posted as initial margins on trades. They have used a tiered approach: 0-3m at 3.5%, 9m-3.25 yrs at 4%, 4.5% increase from 3.25 to 7yrs, and finally 5% increase from 7yrs to 30 yrs, and index linked go from 9% to 14%. ? The effects apply to both repos and reverse. So this effects everybody.
CC&G, the clearing house that most of the Italians belong to had the identical haircut schedule until yesterday. After speaking to MTS this morning they are expected to follow suite soon.
Comments: While this is not the haircut increases being feared by the market over the last few days, this is clearly removing liquidity from the system and implies (back of the envelope) about e5.5bn of cash to be posted on top of what was posted yesterday.
Funding and repo can still be accessed at the ECB but Banks and other Institutions will looking to have diverse sources of funding away from the ECB. As an aside, the ECB funding was already cheaper than LCH yesterday (and a lot cheaper today).
Question now is what Italian debt holders will do in the face of these developments, i.e. sending the cash or reducing their holdings. One thing for sure, there are a lot of sellers on the sideline in Italian bonds and the news is creating more marginal selling while the only proper buyer is the ECB and despite increasing the size of their average clip size, have so far failed to help yield.
Italian 10 Year is now at 6.96% and the spread to the blended AAA at 4.45%. 450bps for more than 5 days is when the actual haircuts get bumped by 15% (from 7.5% from 22.5%) at LCH – this would be very negative. ? Please note the difference between the initial margin on collateral (i.e. what changed overnight) and the actual haircuts on repo (which is what could change if things continue to deteriorate).
Views: We understand the grind higher is driven by the lack of positioning and what looks to be a sub par growth US economy (rather than a recession).
But we feel that American and Asian investors are still too hopeful of a great solution in Europe. The last few weeks have showed disappointing actions out of Europe and lots of promises and few hard facts about a solution. Post the bounce of the last few month, we would rather have a short bias at this point in Europe but given the risk for a squeeze (who can afford to lose money in Q4 if markets are up), we would favour Gamma as a way to get positioned on any big move. We would use any softness in Vols to increase long Gamma/Weighted Vega longs and would actively trade futures to handle the theta bill. ? While buying puts will give more leverage to the downside, owning puts will protect clients against a squeeze risk (if Berlusconi does end up leaving – promises over facts) and the steepness of the skew will make upside cheaper to carry as well.
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