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Categorized | Banks, Insurance

UK banks welcome liquidity swap ruling

Posted on February 29, 2012

UK banks can use complicated asset trades with insurers to help achieve tough liquidity rules, the UK Financial Services Authority announced, cheering industry groups which had feared the transactions would be banned.

The FSA has been consulting on so-called “liquidity swaps” since July and delayed several deals, including a £1bn seven-year deal between Phoenix and a high street bank and a multiyear trade that Lloyds Banking Group tried to do with its Scottish Widows life assurance arm. On Wednesday, it formally blessed the idea. “We see a role for these transactions on a sensible scale, provided the risks are properly identified and managed by both parties,” Paul Sharma, FSA policy director, wrote in new guidance.

In a liquidity swap, an insurer, pension fund or other asset manager will lend a bank a large portfolio of gilts or other highly liquid bonds typically for between three and 10 years. The loan of these gilts is secured by a larger pool of collateral that can include mortgage-backed bonds, infrastructure debt or other less-liquid assets.

The deals allow the bank to boost its stock of liquid assets, as required by new UK and global banking reforms, while giving the insurer higher returns than those achievable from gilts.

But the transactions carry risks for insurers because they may not have the expertise to manage more complicated assets and they increase the links between banks and insurers during a crisis period. The FSA said in its guidance that it will continue to study the implications for financial stability.

The FSA’s views on these transactions are particularly important because the UK has been a world leader in liquidity regulation. After the run on Northern Rock and the collapse of Lehman Brothers, the City watchdog published standards well in advance of global agreement by the Basel Committee on Banking Supervision. Since the global rules are still being adjusted and will not become mandatory until 2015, the FSA guidelines could well become the worldwide benchmark.

The guidance is substantially friendlier to the transactions than a draft version that was published last July.

“We are quite pleased … It is a big improvement over what they initially came out with. The tone has changed. There is an admission that these liquidity swaps can be a good thing,” said John Breckenridge of the Association of British Insurers.