HK exchange prepares for US bond default Hong Kong's exchange has decided that some short-term US Treasury bonds are more risky to hold as collateral, and has implemented extra financial buffers to protect against the possibility of a US default. The move is the first sign in Asia that the possibility of the US government defaulting on its debt is prompting key financial institutions to act to protect themselves and markets with little sign of an end to Washington's debt gridlock. IN Clearing & Settlement It came as the Asia Securities Industry & Financial Markets Association (Asifma), which represents banks, brokers and asset managers in the region, warned that any announcement by the US Treasury in advance of a default must arrive before the opening of the day's trading in Asia or risk "chaos." Japan's clearing house, the Japan Securities Clearing Corporation (JSCC), said it was in "intensive discussions" to prepare for "anything that might happen." Hong Kong Exchanges & Clearing (HKEx) said on Thursday it had taken two measures designed to reflect the increased difficulty of valuing certain short-term US Treasuries amid the debt impasse. First, its clearing house would apply an increased "haircut" to its valuation of US Treasuries held as collateral against futures trades. For bonds held with maturity of less than one year, that would be raised from 1 per cent to 3 per cent, effective immediately, HKEx said in a circular to members. "This new haircut shall be applied on a daily basis to determine the value of the US Treasuries allowed to be used as cover for the margin requirements of HKCC [Hong Kong Clearing Corporation] participants," HKEx said. Participants should make necessary funding arrangements to cover any shortfall to their margin requirements resulting from the increase in the US Treasuries haircut. Clearing houses routinely apply a discount, or "haircut" to the valuation of collateral that members must place with them - such as government bonds - to take account of fluctuations in prices and the fact that some bonds are less liquid than others. With its move on short-term US Treasuries, HKEx is effectively saying it believes that with the possibility of the US government defaulting, the haircut usually applied should be increased to reflect that heightened risk. HKEx also raised the margin that traders must pay to trade futures contracts on the Hang Seng index made up of about 40 blue-chip Chinese "H" shares, such as PetroChina, Sinopec and China Construction Bank. At JSCC, Japan's biggest clearing house, US Treasuries account for a small proportion of overall non-cash collateral. Yet the group's risk management team has been in "intensive discussions" to prepare for "anything that might happen," said Kay Lin, chief manager of the strategic planning group. That could involve cutting the "assessment rate" for US Treasuries, she said, so that participants have to put up more collateral to reflect the higher risk of the securities. Mark Austen, chief executive of Asifma, said it was vital that any announcement made by the US Treasury that the government was about to default be made before Asian markets open on October 17 - the deadline for the US government to raise the country's borrowing limit. It has the potential to cause chaos and people may dump Treasuries because they won't know whether they can exist the next day. They [Treasury] need to make that call early and not late," he said. The Hong Kong regulator is among those taking steps to ensure the market is prepared for any potential US debt default, including talking to other regulators in Luxembourg and Ireland. The Securities and Futures Commission's special intermediaries group and risk group are both asking local institutions about their plans to cope with any technical default. One of the main concerns is the use of Treasuries as collateral and whether they can be easily replaced or supplemented once their values are marked down in the event of a default. However, Alexa Lam, deputy chief executive of the SFC, said Treasuries make up a relatively low share of the collateral used in Hong Kong and Asia more broadly. Additional reporting Paul J Davies in Hong Kong