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Last updated: May 29, 2012 11:28 pm
Morgan Stanley’s plan to shift a large chunk of its $52tn derivatives portfolio into the part of the group backed by customer deposits is facing regulatory obstacles, according to people familiar with the situation.
Under the plan – partly an attempt to reassure trading partners of its financial strength ahead of a looming credit downgrade by Moody’s – Morgan Stanley would move derivatives into its bank subsidiary, which has a higher credit rating than the group as a whole.
But the US Federal Reserve has yet to approve the request after considering it for an extended period.
The derivatives move should also make it less likely that counterparties take their business from Morgan Stanley to higher-rated competitors such as JPMorgan Chase even if Moody’s follows through on a threat to downgrade its credit rating by up to three notches to Baa2 from A2.
Morgan Stanley’s bank is seen as a safer entity than the holding company because it is funded with customer deposits and can borrow from the Fed’s discount window.
Analysts at Credit Suisse estimate Morgan Stanley could receive an earnings boost of between 5 and 25 cents a share from lower funding costs if it shifts more derivatives to the bank subsidiary.
But regulators have not yet ruled on the request. Under a lengthier process introduced by the Dodd-Frank financial reforms, the Fed is required to formally consult on such moves with the Federal Deposit Insurance Corp, complicating the issue.
The Fed, which oversees Morgan Stanley as a financial group and looks to safeguard the stability of the broader financial system, has a different mandate from the FDIC, whose concern is safeguarding bank deposits.
The Morgan Stanley request could put the regulators on either side of the argument, though both declined to comment.
If Morgan Stanley is barred from moving its derivatives portfolio it will raise questions about why rivals such as Goldman Sachs have been allowed to do so in the past. Only 3 per cent of Morgan Stanley’s derivatives exposure is held in the bank subsidiary compared with more than 90 per cent for most of its US rivals.
The potential Moody’s downgrade of the sector, which is expected to hit a host of financial groups across the world, could cost Morgan Stanley up to $9.6bn in collateral calls, the company has said.
While it is waiting, or if the bank move is denied, Morgan Stanley could warehouse derivatives in a separate subsidiary called Morgan Stanley Derivative Products that has a higher credit rating.
“We think the potential outcomes are manageable,” Ruth Porat, chief financial officer, told analysts in April.
Morgan Stanley’s notional outstanding derivatives position was $52.2tn at the end of last year, according to regulatory filings, representing about 7 per cent of the total market. On a net basis its derivatives exposure is much lower.
Dodd-Frank contains another headache for financial groups wanting to house derivatives in their bank subsidiaries with a requirement, yet to come into force, that certain classes of derivatives – those that reference commodities, for example – are held outside the bank.
But Credit Suisse estimates that would affect less than 5 per cent of the Morgan Stanley portfolio.
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