According to a Credit Benchmark report, trading costs for the European buy side could increase by up to €40 billion due to new securities lending regulations.
The new Basel regulations that will come into force in 2025 should see high quality credits without external rating increase their risk weighting to 100%. The rise will lead to a dramatic increase in capital requirements.
Following concerns expressed by industry players about impending changes to risk weightings, the European Commission has proposed that there be a transitional regime for unrated companies and funds, whereby institutions based on internal ratings ( IRB) would apply a preferential risk weight of 65% to their exposures to companies and funds that do not have an external rating, provided that these exposures have a probability of default less than or equal to 50 basis points.
However, according to the Credit Benchmark report, even with this transitional arrangement, the new rules will have a “dramatic” impact on the buy side which will see spreads widen and liquidity shrink.
The company predicts that the changes will lead to the cessation of general collateral (GC) securities lending due to a reduction in the annualized income of €1.2 billion that European savers currently receive. They could also trigger a decline in securities financing activity which Credit Benchmark predicts will dry up market liquidity.
The result could be a widening spread range that could increase trading costs for the buy side by €20 billion to €40 billion per year.
“As costs rise there is likely to be a depressing impact on volume, although the sensitivity of this is unclear,” said Thomas Aubrey, risk adviser at Credit Benchmark and author of the report. .