Seer Capital Management, a hedge fund specialising in significant risk transfers (SRTs) since 2010, has warned that restricting the use of leverage in transactions could increase the cost of credit for consumers and businesses, according to a report by Bloomberg.
SRTs are financial tools that help banks improve their capital buffers, enabling them to lend at lower costs. In these deals, banks offload a portion of their risk from loan pools—ranging from car loans to corporate debt—to investors. These investors, in turn, earn yields often exceeding 10% for taking on junior losses, Seer Capital said in a note obtained by Bloomberg News.
According to the New York-based alternative asset manager, leverage plays a crucial role in making SRTs more competitive. By enabling a broader range of money managers to participate, leverage drives competition, ultimately benefiting banks and lowering their costs. Additionally, some lenders use SRT pricing as a benchmark for setting rates on other lending products, said Seer’s Managing Director Terry Lanson and Head of Strategy and Research Karen Weaver.
SRTs, also known as regulatory capital (reg cap) transactions, have come under heightened scrutiny due to a surge in issuance in recent years. The European Central Bank (ECB) is closely monitoring the use of leverage in SRTs, even as it experiments with an expedited approval process for the transactions. Similarly, the International Monetary Fund (IMF) issued a warning in October, suggesting that leveraged SRTs could pose risks to financial stability because “substantial risk” may remain within the banking system.
However, Seer Capital disputes these concerns. “Various parties have raised concerns about reg cap financing based on the claim that reg cap risks must leave the banking system entirely,” the firm said in the note. “These critics are off the mark in our view,” noting that risk is mitigated by measures such as collateral requirements and mark-to-market margin calls for leveraged SRT investors.
Seer Capital argues that SRTs are especially attractive to banks because their pricing remains more stable during periods of market turbulence compared to alternatives like junior tranches of collateralised loan obligations.
The hedge fund estimates that approximately €10bn ($10.4bn) of leverage has been used to fund about €60bn worth of SRT transactions—a scale that Seer considers far from systemically risky.
“This is hardly of a magnitude that could give rise to systemic risk,” the note stated. “It is routine and entirely appropriate for banks to offer structured financing arrangements for assets that would be unsuitable for them to hold directly on balance sheet.”
