Safe-asset demand risks "collateral crunch" Growth in demand for safe assets in Europe's financial system will far outpace growth in supply in the next two years, heightening risks to financial stability, the continent's markets regulator has warned. Worries about a possible "collateral crunch," which also could restrict the provision of credit to the real economy, have risen since the global financial crisis erupted. Lenders have demanded more collateral as security while regulators have demanded that trades, for instance in financial derivatives, are backed by larger financial cushions. In Europe, the sovereign debt crisis has depressed the supply of higher-quality collateral, while tensions in the financial system have been particularly acute in some crisis-hit eurozone countries. Highlighting official concern, the Paris-based European Securities and Markets Authority on Wednesday included a special section on collateral in its first report on possible vulnerabilities in EU securities markets. According to Esma's estimates, demand for collateral will rise from €4.07tn in 2012 to €6.51tn in 2014 - and increase of €2.44tn. The total supply of collateral would remain considerably ahead of demand, but the pace at which it increased was forecast to be noticeably slower. The value of available collateral, would rise from €11.81tn last year to €12.63tn in 2014, an increase of less than €1tn. The report said: "This trend could heighten financial stability risk, as financial institutions lacking higher-quality collateral may use lower-quality collateral to mitigate their counterparty risk, enter in collateral swaps with third parties or pledge some of their assets, resulting in rising asset encumbrance." The Esma report concluded: "It appears that there is no shortage of collateral but rather relative collateral scarcity. In view of the potential financial stability risks linked to relative collateral scarcity, the availability and use of collateral needs to be monitored. The availability of collateral will thus remain a concern for a while. Among vulnerabilities identified by Esma was the possible negative impact of changes in the value of collateral on the financial intermediation role played by hedge funds and prime brokers, "which may lead to scarcer collateral, reducing liquidity and ultimately hamper repo financing [collateralised short term market funding trades]." Estimates about the impact of tougher regulations globally on collateral demand have varied wildly. Particularly controversial are estimates of the amounts which will be required in the future to back trades in financial derivatives that are not cleared through "central counterparties," or institutions which stand between two parties in trades ensuring they are completed in the event of one side defaulting. The International Swaps and Derivatives Association has said the extra collateral required globally could be as high as $10tn.