Investment Operations

Financial Counterparties Experienced Widespread Deterioration

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Financial counterparties have experienced widespread deterioration, according to the latest Credit Benchmark consensus data.

The latest analysis by the Financial Counterpart Monitor indicates banks of all types have seen their credit quality decline. The largest shift, according to the report, was with Latin American banks, as seen by a 14:1 ratio showing far more deterioration than improvement. North American banks and G-SIBs were the next most negatively affected with ratios of 4:1 each. Last month’s worst performing category, APAC banks, saw the least deterioration this month but the ratio was still tilted towards downgrades at 1.7:1. 

The data indicate that intermediaries performed a little better. “The brief respite enjoyed by Prime Brokers last month is over,” according to the report, “with this category’s ratio now at 5:1 deteriorating to improving.” Custodians and Sub Custodians, Broker Dealers, and CCP Members showed ratios of 3:1, 2.5:1, and 2.1:1, respectively, and this comes on top of previous deterioration. Only CCPs themselves were unchanged this month, the report indicated.

David Carruthers, Head of Research at Credit Benchmark, warned that The latest update shows a few areas of concern. “Consensus risk data show deterioration across all types of banks, especially those in Latin America and G-SIBs,” said Carruthers. “The core plumbing of the financial system also shows signs of strain, with four out of five categories of intermediaries seeing more downgrades than upgrades, led by prime brokers; a group heavily involved in multiple ends of the financial system. This is an area worth keeping an eye on,” he added.

In this latest report, the buy-side shows a mixed picture. Ratios for Sovereign Wealth Funds and Insurance firms had ratios of 3:1 and 1.5:1 deteriorating to improving respectively, while Pension Funds and Mutual Funds saw more improvement than deterioration and were at a ratio of 0.6:1 each.

Carruthers noted an article by Valeri Sokolovski, Magnus Dahlquist, and Erik Sverdrup in Fortune earlier this year, in which the authors opined that “the risk of a prime broker shock negatively affecting their hedge fund clients is much larger than any potential risk of a hedge fund adversely affecting its prime broker.”