In
finance
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of f ...
, a haircut is the difference between the current
market value
Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with ''open market value'', '' fair value'' or ''fair market value'', although th ...
of an asset and the value ascribed to that asset for purposes of calculating
regulatory capital or
loan collateral. The amount of the haircut reflects the perceived risk of the asset falling in value in an immediate cash sale or liquidation. The larger the risk or volatility of the asset price, the larger the haircut.
For example, United States
Treasury bills, which are relatively safe and highly liquid assets, have little or no haircut, whereas more volatile or less marketable assets might have haircuts as high as 50%.
Lower haircuts allow for more
leverage. Haircut plays an important role in many kinds of trades, such as
repurchase agreements (referred to in debt-instrument finance as "repo" but not to be confused with the concept of
repossession
Repossession, colloquially repo, is a "self-help" type of action, mainly in the United States, in which the party having right of ownership of the property in question takes the property back from the party having right of possession without in ...
denoted by that term in
consumer finance
Personal finance is the financial management which an individual or a family unit performs to budget, save, and spend monetary resources over time, taking into account various financial risks and future life events.
When planning personal fin ...
) and
reverse repurchase agreements ("reverse repo" in debt-instrument finance).
In mass media,
as well as in
economics
Economics () is the social science that studies the production, distribution, and consumption of goods and services.
Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics anal ...
texts, especially after the
financial crisis of 2007–2008
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of ...
,
the term "haircut" has been used mostly to denote a reduction of the amount that will be repaid to creditors,
[ or, in other words, a reduction in the ]face value
The face value, sometimes called nominal value, is the value of a coin, bond, stamp or paper money as printed on the coin, stamp or bill itself by the issuing authority.
The face value of coins, stamps, or bill is usually its legal value. Howe ...
of a troubled borrower's debts,[Not just state- but also corporate-debt. Se]
"Private equity firm bosses to get $370M windfall in Caesars mess"
'' The New York Post'', 22 August 2016 as in "to take a haircut": to accept or receive less than is owed. In 2012, world media was reporting on the "biggest debt-restructuring deal in history", which included the "very large haircut" of some "70 percent of par value
Par value, in finance and accounting, means stated value or face value. From this come the expressions at par (at the par value), over par (over par value) and under par (under par value).
Bonds
A bond selling at par is priced at 100% of face valu ...
" of Greek state bonds, in NPV terms.[
]
SEC net capital rule
The financial term "haircut" began, and continues to be used, as a reference to valuation discounts applied under the U.S. Securities and Exchange Commission's net capital rule
The uniform net capital rule is a rule created by the U.S. Securities and Exchange Commission ("SEC") in 1975 to regulate directly the ability of broker-dealers to meet their financial obligations to customers and other creditors. Broker-dealers ...
. The net capital rule was adopted to provide safeguards for public investors by setting standards of financial responsibility to be met by broker-dealer
In financial services, a broker-dealer is a natural person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and ...
s and requires a broker-dealer to have at all times sufficient liquid assets to cover its current indebtedness. The SEC explained the role of haircuts in calculating net capital in 1967:
In computing "net capital," the rule requires deductions from "net worth" of certain specified percentages of the market values of marketable securities and future commodity contracts, long and short, in the capital and proprietary accounts of the broker or dealer, and in the "accounts of partners." (These deductions are generally referred to in the industry as "haircuts.") . . . The purpose of these deductions from "net worth," is to provide a margin of safety against losses incurred by a broker or dealer as a result of market fluctuations in the prices of such securities or future commodity contracts.
"Haircut" since has been extended to a number of other financial contexts, whenever it is desirable to show that some securities (typically debt securities) are being valued for some purpose at a discount.
ECB use of haircuts
The European Central Bank
The European Central Bank (ECB) is the prime component of the monetary Eurosystem and the European System of Central Banks (ESCB) as well as one of seven institutions of the European Union. It is one of the world's most important centra ...
applies a haircut to all securities offered as collateral. The size of the haircut depends on the riskiness and liquidity of the security offered as collateral.
LTCM and haircut fees
The hedge fund
A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as ...
Long Term Capital Management (LTCM) saw spectacular losses that led to its dissolution in 1998. It had previously been able to trade with little collateral on positions that were considered safe by its lenders.
As used for exchange-traded products
When used in the context of exchange traded products such as stock
In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a compan ...
s, options
Option or Options may refer to:
Computing
*Option key, a key on Apple computer keyboards
*Option type, a polymorphic data type in programming languages
*Command-line option, an optional parameter to a command
*OPTIONS, an HTTP request method
...
, or futures
Futures may mean:
Finance
*Futures contract, a tradable financial derivatives contract
*Futures exchange, a financial market where futures contracts are traded
* ''Futures'' (magazine), an American finance magazine
Music
* ''Futures'' (album), a ...
, haircut is used interchangeably with the term margin
Margin may refer to:
Physical or graphical edges
* Margin (typography), the white space that surrounds the content of a page
*Continental margin, the zone of the ocean floor that separates the thin oceanic crust from thick continental crust
*Leaf ...
. It is the amount of capital required by a broker to maintain the positions currently in a trading account. If haircut exceeds the account's capital, the broker can either require additional capital (e.g., margin call), or liquidate positions until the haircut no longer exceeds available capital.
In sovereign debt write-downs
During the Eurozone crisis, and particularly in the context of the Greek financial crisis, the term "haircut" acquired more specifically the meaning of state-debt holders receiving less than par.[ It's "the market's euphemism for wiping out a large portion of the debt owed to the creditors".
The haircut agreed to by Greek-state debt holders was deemed "voluntary" by the banks' chief negotiator Charles Dallara, although, in order to convince domestic bond holders, the Greek government "made it clear that holdouts would not receive a sweeter deal", while it also declared that if the haircut was not completed, the Greek state would not be able to "further service its debt".]
Notes
References
External links
Collateral Management
on Financial-edu
Haircut
on Investopedia
Investopedia is a financial media website headquartered in New York City. Founded in 1999, Investopedia provides investment dictionaries, advice, reviews, ratings, and comparisons of financial products such as securities accounts. Investopedia h ...
Collateral Value
on Investopedia
{{stock market
Loans
Bond valuation
category:Credit