Sunday, August 24, 2014

Cross Margin across OTC and ETD derivatives

Since the financial crisis, regulators are forcing banks and other market participants, through different methods such as less capital charge for OTC trades that are cleared with central counter parties (CCP), to move towards the central clearing model. In 2009 ,in light of credit crisis, G20 countries have stated their ambition of moving from a bilaterally OTC market to a centrally cleared model.This kicked off a new wave of regulations related to centrally cleared OTC market.

In mid of these developments exchange or CCPs realized that, with more and more OTC derivative trades cleared through them, they can provide the clients more benefits,less margin requirements, with cross margin across different products, standard exchange traded products and OTC trades. Now Eurex, Frackfurt based exchange and clearing house is challenging another London based clearing house ,LCH.Clearnet's Swapclear with already released cross margining platform.

One head of rates trading at US bank in London mentioned that this is going to be a clash of titans."SwapClear is the dominant incumbent, Eurex the upstart with a service that has value-add. It's going to be a huge fight."

Oliver Wyman study claims that a global dealer would save up to 75% more by using Eurex Clearing than at what it coyly terms a baseline CCP, relative to the costs of trading OTC derivatives bilaterally. Regional banks could save up to 100% more, while savings for a fixed-income mutual fund could be up to 70% higher. In total, the incremental savings available at Eurex could be up to €5 billion for buy- and sell-side firms combined, the study claims.

Benefits come from allowing participants to cross-margin their euro swaps exposures with other products they are clearing at Eurex, which include repo and securities lending transactions, as well as the exchange's crown jewel – its huge pool of Bund, Bobl and Schatz interest rate futures. This could generate savings of 3–8 basis points over those available at a CCP with no ability to cross-margin. 

The second benefit is the integrated default fund at Eurex. In practice, this means all clearing members contribute to a single pot of money, allowing offsets to be applied. The total size of the default fund is calculated by estimating the amount of cash needed to contain the losses resulting from the collapse of the two clearing members to which the CCP has most exposure. In theory, offsets across cleared products mean individual members will present less net risk, translating into a smaller default fund and lower capital requirements for members' contributions to the fund. This contrasts with LCH.Clearnet's approach, where the CCP's six product lines are backed by separate default funds.LCH is also going to launch it's cross margining platform. 

There are some more factors such as operation burden while switching from one clearing house to another clearing house, BCBS has revised the calculation framework for CCP exposures and experts have said that this has weekend the Eurex position. 

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