Fund-linked structurers in London are griping over a U.K. interpretation of Basel II they say is punitive to fund derivative businesses. Firms including Barclays Capital have had to cut back on certain hedge fund financing strategies, structured through loans, because of the capital treatment cost. Firms in other jurisdictions may also face this problem but some local regulators--including in the U.S.--have yet to clarify interpretations of Basel II.
In a loan-note financing, the dealer lends money to a hedge fund in return for a loan note and collateral. The loan is being viewed as a commercial-banking product so the capital requirement is high. This is compared to an option- or swap-based structure, which can qualify as a trading-book instrument and can be marked to market.
Firms providing fund leverage through options or swaps have gone through lengthy negotiations with the Financial Services Authority and internal risk managers to get value-at-risk models approved for calculating trading book capital requirements. An official at Credit Suisse said it began this process over a year ago. "Businesses which started late and are adopting more of a standard treatment are getting hit much harder," he added.
While other U.K. firms such as The Royal Bank of Scotland may also have been affected, Barclays has been worst hit because it runs the largest fund-linked business in the U.K. It also appears to have had more business structured through loan notes rather than through options or swaps compared with other large fund-linked firms such as SG Corporate & Investment Banking and BNP Paribas. Its U.S. fund-linked business is also affected because the risk is managed out of the U.K.
Barclays is now looking to transfer some existing structures to swap or option strategies. One U.S. fund-of-funds manager which has a loan-note financing from Barclays said the firm asked it to change the structure. The manager declined, because of disadvantages with both alternatives: option financing is expensive unless the fund is able to provide good liquidity, and the tax treatment of the swap structure is uncertain. He noted, however, that he still views the firm as a good counterparty and would work with it again.
Barclays and RBS officials were not available for comment. Joseph Eyre, spokesman at the FSA, said the regulator was not aware of the issue and had not received any complaints regarding its capital treatment for hedge fund collateral as opposed to that of other jurisdictions.
