Debt Ceiling Uncertainty and What it Means for Collateral Management
The US government Debt Ceiling debate has dominated media coverage of late, and it’s clear to see why. Never in history has the US government defaulted on its debt… yet. While there is no historical precedent for what would happen if the US were to default on its debt, it’s prudent to project the potential implications of such a default, and to plan accordingly. As the Debt Ceiling debate takes center stage, we look at what might be in store and how Hazeltree can help.
While it’s challenging to predict unprecedented events, we believe a breach of the debt ceiling would result in certain actions. Firstly, we believe the US Treasury would reduce the issuance of new treasury bills until the debt ceiling issue was resolved. This reduction in supply would result in reduced yields for any bills maturing in Q4 2023 or later. Any treasury bills posted as collateral would see a corresponding increase in value, resulting in some agreements being overcollateralized. However, this would only pertain to agreements without ratings thresholds governing asset eligibility.
For agreements where eligibility is based on credit ratings, we could, at least in the short term, face a situation in which US government securities become ineligible. As Fitch Ratings reported, “If the limit were not raised or suspended in time to avoid a default, the US’s rating would be moved to ‘RD’ (Restricted Default). Affected Treasury securities would carry a ‘D’ rating until the default was cured.” This would require parties posting these securities as collateral to recall and substitute them with other assets. It is possible that if the debt ceiling were breached, the US government may choose to pay obligations on maturing treasury securities by prioritizing them over other government obligations, such as payments to certain government programs. While that may avoid a default rating, it may not entirely solve the problem. As Fitch Ratings also reported, “Prioritizing debt payments to avoid an immediate default, if this were possible, might not be consistent with a ‘AAA’ rating.” Furthermore, if only a temporary solution is used to resolve the default, such as a modest debt ceiling increase that only lasts a few months, ratings may not immediately recover due to the concern that the debt ceiling could be breached again in the short term. These factors may still leave some rating-dependent collateral agreements in limbo.
Here are ways that you can use Hazeltree to ensure you are ready to manage your collateral needs in all possible scenarios:
- Get a clear picture by centralizing your view of outstanding collateral, analytics, and counterparty exposure.
- Clean house by identifying new opportunities to recall excess collateral and improve liquidity.
- Monitor all exposures closely – on an agreement-by-agreement basis.
- Check compliance to ensure you are currently meeting contractual collateral requirements, Uncleared Margin Rules, and general regulatory collateral requirements.
- Be ready to take action quickly – automate the daily call management process with straight-through processing of margin call workflows and keep an eye on exceptions.
- Set up direct connections to key counterparties so you are ready execute the necessary transactions.
Hazeltree Collateral Manager enables clients to monitor counterparties, mitigate risk and minimize capital encumbrance across uncleared OTC and bilateral repo transactions, thereby protecting clients while optimizing usage of liquidity.