Trading Firms Could Save $1T with One-Pot Margining
Traders Magazine Online News, November 8, 2012
Firms can pick up a trillion dollars in savings on their trading in over-the-counter derivatives, with a new form of calculating collateral.
That’s the amount of potential savings when “one-pot” margining starts being offered by clearing houses, industry consultant Tabb Group says.
The practice, more formally known as portfolio margining, allows firms to keep on hand only enough capital to meet the ‘net risk’ of all the positions they hold in swaps and other derivatives, such as options. The amount of collateral needed for that tends to be less than that required to be kept on hand for a large amount of individual positions.
The portfolio approach to calculating margin can reduce risk in trading and processing these controversial OTC contracts, says Tabb. A large part of the credit crisis of 2008 and 2009 was laid at the feet of credit-default swaps.
The majority of swaps going forward will be handled on exchanges, as standardized contracts, with risks being assumed by a central clearing house.
With the mandate for such clearing brought on by the Dodd-Frank Wall Street Reform Act, portfolio margining will be critical tool in keeping initial margin costs down, Tabb Group said in a recent report.
For instance, when all clearable interest rate swaps are eligible for portfolio margining, “the industry will see margin savings of $618 billion. And if more linkages are created among the Central Counterparty Clearinghouses (CCPs), the savings could reach as high as $1 trillion,” according to the report, titled “Portfolio Margining for Rates: Saving on Clearing.”
Regulators, industry participants have said, have a difficult task in making these OTC derivatives products safe. If the requirements are too big, they could limit use of the contracts. On the other hand, margin and collateral requirements must be big enough to protect all parties. That’s in case one of them fails or a number of them fails simultaneously, posing the problem of systemic risk.
Portfolio margining enables firms to reduce margin burdens by leveraging offsetting risks in portfolios. When it becomes widely available, it will reduce the margin requirements by 32 percent, the report said.
Who benefits the most?
Tabb said dealers that act as market makers and middlemen between users, asset managers, insurance companies and hedge funds. Big banks will also be helped by these savings.
The $1 trillion savings estimate, the report adds, is an estimate. It is based on the August 2012 estimate of the notional value of interest rate swaps at $514 trillion. That would require some $7.1 trillion in gross initial margin.
Regulators are still working on the rules of which OTC derivatives must be cleared under the Dodd-Frank Act. Most will be cleared. A few will be exempted from the clearing mandate.
Those exempted will generally be exotic, personalized contracts that have thin markets. They will also require bigger margin and collateral requirements. That’s because they use a dealer-to-dealer, bi-lateral model, a model that regulators view as more dangerous than going through a clearinghouse.
“Exotic products face possible extinction,” warns Adam Sussman, the author of the report, “unless the cost of these uncleared, capital intensive contracts can be lowered.”
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