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By Cecile Lefort
SYDNEY, Aug 20 (Reuters) - Australian fund managers are flexing their muscles against long-dominant investment banks, demanding the banks provide them with more equitable protection in the A$29 trillion ($21 trillion)credit and interest-rates swaps market.
Investment funds are stipulating that banks post collateral in over-the-counter derivatives agreements to protect funds should a bank become insolvent, and are widening the classes of collateral they themselves wish to post.
Traditionally, investment banks have required funds to post collateral but rarely reciprocated, a fact that has changed since Lehman Brothers' collapse in 2008 made clear the risks bank insolvency could pose in such agreements.
"Banks were worried about us, but we were not allowed to worry about them," said James Alexander, head of fixed income at Nikko Asset Management. "Now, we can demand collateral from them."
Investment funds are pressing counterparty banks to accept a more diverse range of assets as collateral - beyond the usual cash or government bonds which funds consider a drag on their balance sheets.
Earlier this month, Colonial First State, one of Australia's top investment firms with about A$200 billion of assets under management, deployed a "credit support deed" in a deal that allows it to provide collateral of its own choosing and to ring-fence it from the counterparty.
Swap deals are usually based on a standard document created by the industry's International Swaps and Derivatives Association (ISDA), yet can vary greatly in the detail.
Colonial has taken a bond held by one of the firm's funds, placed it in a segregated account and then provided an equitable mortgage on the asset as collateral, ensuring the legal title to the asset stays with the fund.
"That way, it removes a number of weaknesses of the standard credit support agreement," said Tony Adams, head of Colonial's global fixed income and credit team in Sydney.
Of particular concern to funds was the risk they could lose control of the assets. Under typical master agreements, the collateral to be returned need only be of the same type and value as the collateral posted, not identical.
That meant an asset manager who, say, posted a two-year government bond could be given a 10-year bond of the same value in return when the contract ends, potentially breaching portfolio mandates and affecting a fund's duration strategy.
Nikko Asset Management, which manages A$24 billion of assets in Australia, said it was also exploring alternative collateral assets such as state-government bonds and those issued by supra-national institutions - typically AAA-rated borrowers such as the World Bank or the Asian Development Bank. ($1 = 1.3607 Australian dollars)