Market Watch

Europe May Just Pull the Switch on Its Own Electric Chair

The shadow banking system is an integral part of the systemic rehypothecation pie. Leveraging off of other people collateral and assets to make other purchases and investments represents around 80 trillion in the world’s current Janga structure. In order to reign in and temper this time honored practice and bring greater “stability” to the system, there is a proposal to clamp down in the EU (30 Trillion). This may indeed bring greater stability in the long run. What chain of events however will occur in the short term if that is suddenly shut off…..

Bloomberg has just reported that Europe may begin a crackdown on that most important credit money conduit: the $80 trillion+ global shadow banking system, by effectively collapsing collateral chains, and by making wanton asset rehypothecation a thing of the past, permitted only with express prior permission, which obviously will never come: who in their right mind would allow a bank to repledge an asset which may be lost as part of the counterparty carnage should said bank pull a Lehman. The result of this, should it be taken to completion, would be pervasive liquidations as countless collateral chain margin calls spread, counterparty risk soars all over again, and as the scramble to obtain the true underlying assets finally begins.

Banks and brokers face a clampdown on using assets they hold for clients as collateral for their own trades as part of European Union moves to bolster market stability and rein in shadow banking.

The European Commission is weighing whether firms should have to obtain formal consent from their clients before being allowed to reuse assets to back other trades, according to a document obtained by Bloomberg News. The consent would be enshrined in a “contractual agreement” between the parties.

The handing over of collateral is an integral part of repurchase agreements, or repos — one of the activities under review by global regulators as part of their efforts to regulate shadow banking. The reuse of clients’ assets poses a potential threat to financial stability should one of a chain of firms that handled the securities go bankrupt, according to the document prepared by commission officials and dated May 15. Uncertainty about who holds an asset can fuel panic in times of market stress, according to the paper.

“Complex” chains of collateral can make it difficult for investors to “identify who owns what, where risk is concentrated and who is exposed to whom,” according to the document. “This has consequences for transparency and financial stability.”

What do you think will happen when these levered chains are broken….?

Full Hedge/Bloomberg article can be read HERE

A must watch, Kyle Bass (The Man) talks some on Europe and Rehypothecation HERE