Central bank haircuts
Before going into the fundamental factors driving each product pair (covered vs. senior and covered vs. sovereign debt), we want to provide a brief overview of how the various products are treated for repopurposes.
As part of its open market operations, the European Central Bank (ECB) has implemented risk control measures to protect itself from potential collateral losses in case the underlying assets must be liquidated due to a
counterparty’s default. These measures encompass initial margins, valuation haircuts, variation margins, limits,
additional guarantees and exclusions. The value of the underlying asset is calculated as the market value of
the asset less a certain percentage (“valuation haircut”).