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. 

ISDA is going to include new CDS terms from September 2014

International Swaps and Derivatives Association Inc. (ISDA) is updating derivatives credit definition to include the new government bail-in Credit Event trigger for CDS contacts on financial reference entities in non U.S. jurisdiction. ISDA also modify the typical terms of sovereign CDS contracts in wake of recent Greek debt crisis by allowing a buyer of protection to deliver upon settlement the assets into which the Reference Obligation has converted even if such assets are not otherwise deliverable. Further they have more changes and creating a concept called SRO , Standard Reference Obligation.It is proposed that ISDA will publish a list, known as the “SRO List”, of Reference Entities that are frequently traded on the CDS market, and the SRO List will specify a Standard Reference Obligation (and seniority tier) for each of these Reference Entities.This should increase the fungibility of CDS transactions with the same Reference Entity. More details on these changes are here. 

New credit definitions will supersede the ISDA 2003 credit definitions. In 2003 credit definition ISDA had defined six credit events. Historically out of these six, restructuring credit event has been toughest contingency to contract for in a CDS. Contractual conditions affects the pricing of CDS. So there can be spread in 2014 ISDA CDS trade and already traded same CDS on 2003 ISDA definitions. 
It is anticipated that market participants will begin to use the 2014 Definitions with the September 2014 credit default index swap roll date (i.e., September 22, 2014). The 2014 Definitions will apply to new trades only if so elected by the parties (e.g., by incorporating their terms into a trade confirm). Additionally, ISDA has released a draft protocol that parties can use to elect to have the 2014 Definitions apply to existing trades, although certain existing transactions such as sovereign CDS and CDS on European financial entities are expected to be excluded from the protocol given the substantial impact the changes could have on such trades’ terms and value.
As mentioned by Abel in report, "This credit definition change is Creating a challenge for firms to implement the necessary operational and infrastructure changes."
A CDS portfolio will be consisted of ISDA 2014 credit definition trades, ISDA  2013 credit definition trades and mix of both,as explained below by one of the clearing house at OTC space.

List of recent Risk Management Failures

Risk Management Failures

RBI buying dollars & more dollars

Since last couple of months RBI buying dollar in both cash & future market. In June RBI bought $11.3 bn in future market. This forward exposure may have taken in view of FCNR dollar exposure of RBI. Normally RBI act as stabilizer for INR but recently RBI buying dollar even when INR was depreciating. In June RBI bought $11.8 bn dollar while INR depreciated to 59 from 60. Read the complete story here.
This increased dollar buying could be related to RBI's efforts to build sufficient foreign exchange reserve to face capital account crisis that could arise when US increase the tapering. India faced the crisis in 2013 when INR depreciated to 69 in very short time and volatility of INR was very high. IMF also said  India should prepare a plan to respond to volatility in global currency markets that may come as the U.S. Federal Reserve reduces monetary stimulus, the International Monetary Fund staff said in a report."

Securities Market Risk Survey by IOSCO

Research department of IOSCO published a working paper, “A Survey of Securities Markets Risk Trends 2014: Methodology and Detailed Results,” which provides a detailed analysis of responses to IOSCO’s annual survey on market trends and emerging risks.

According to IOSCO,  "The main purpose of the survey is to gather views on emerging risks to/within securities markets and help identify/highlight pockets of risk that may not be captured by normal statistical analysis or desk research."

Six questions was sent to all potential participant and main question is to " “identify from the 

list, five areas that you see as most important to explore for your jurisdiction when it comes to 

maintaining financial stability"

The main points-

• concerns about “micro-prudential” risks clustered around the areas of corporate governance, financial risk disclosure, shadow-banking activities and regulatory uncertainty;
• concerns about issues considered “macro-prudential,” especially in the areas of banking vulnerabilities and capital flows;
• Responses differ by organisational type; regulators see risk emanating from illegal conduct, corporate governance, financial risk disclosure and benchmarking issues, while market participants are more concerned with risk in the areas of search of yield, resolution and resolvability plans, CCPs and market fragmentation.
• the impact of cross-border flows, financial risk disclosure and CCPs generally has drawn more attention between 2013 and 2014 than previously;
• Three risks have been consistently and frequently mentioned during these three years:
  regulatory uncertainty; banking vulnerabilities; and capital flows.
• Over time some risk areas have gained attention while others have lost attention. The speed of change can be very fast. Sovereign debt and the global economic slowdown were prominent two years ago, but not now. 

Cash Reserve and Liquidity Ratios: A Primer

Cash Reserve and Liquidity Ratios: A Primer

RBI policy review

RBI holds rates, cuts SLR and HTM. Here’s is the complete article on this. Statutory liquidity ratio (SLR) has been cut to 22% from 22.5%. This is a kind of back door easing to banks as now they can lend more. Though some analyst sees SLR as a barrier in financial market development. 

CCP Margin Models | Comparing Historic VaR and SPAN

The SPAN model used in futures clearing can survive in the face of widespread adoption of VaR models in OTC derivatives clearing. Here is the complete article.

The difference between the Value at Risk (VaR) and Standard Portfolio Analysis of Risk (SPAN) market-risk measurement methods has been discussed here.

Collateral reporting requirement for BHCs

During the Financial crisis of 2007-09, it has been observed that financial institutions were far more interconnected and dependent on each other than it was assumed by regulators. Institutions were connected through repo market, for funding need, OTC derivatives and other asset markets. Institutions posted collateral to counterparties  to mitigate the credit risk of transactions in these markets. However During the crisis, rapidly falling asset values, corresponding collateral calls, and stricter collateral requirements led to large losses and subsequent funding needs among financial firms. The degree of interconnection between firms caused these effects to spread more broadly and rapidly than expected. The whole system was more fragile.

Now learning lesson from the crisis, FED required bank holding companies (BHCs) with more than $10 billion to start reporting their collateral arrangements in much greater detail.These data provide insight into counterparties and collateral arrangements in these markets.

“Although BHCs have large exposure to banks, most of the collateral involved maintains minimal credit risk and is highly liquid. Conversely, contracts with corporations tend to use more diverse types of collateral, but the volume of these contracts is only one-quarter that of contracts with other banks,” write Marius Rodriguez and Hamed Faquiryan of the Economic Research Department of the San Francisco Fed. “Moreover, the exposure to hedge fund counterparties is minimal and is collateralized by safe, liquid instruments.” 

In the FED report it also has been observed that collateral posed by hedge funds not only managed actively but also posted collateral is more than total exposure. This type of information can play a important role in understanding the linkage of financial institutions and can be very helpful to keep a check on whole system.

GS shredding less profitable hedge fund clients

Goldman Sachs cutting some Less-Profitable Clients as new capital rules takes their roll.
Also it is  increasing some fees on others as it adapts to new banking rules, people familiar with the matter said.

The bank has told hedge-fund clients that the regulations have forced it to set aside more capital, crimping profits at its prime-brokerage business, which executes and finances the funds’ trades.

Recently GS has achieved 4.5% leverage ratio but this needs to be go up to 5% by 2018  as per new regulatory requirements.

Goldman to offer bond using the TRS

Goldman Sachs is planning €10B in sales of a controversial new type of bond that utilizes total return swaps, at the same time the derivatives are gaining popularity in the market due to the historic lows of credit investments.
TRS, Total return swap, is type of credit derivative that allows investors to get the exposure to portfolio of bonds, loans etc. without actually owning these assets. Investors pay the fees to the return payer to get the total rate of return on desired portfolio, without owning it. The investor, receiver of the TRS, must pay any decline in price to the TRS payer. If there is no decline in price than investor does not need to make a payment. If price gets appreciate than investor gets the appreciated amount from the return payer. It is like investors does not own the referenced portfolio laegally but return profile will be same as like investor owns the asset.
TRS is not new product and it has been around at least since 1987 when Salomon Brothers offered the first mortgage swap agreement (“MSA”). 

“They can be used as a mechanism to get short or get long – you can go long something that you can’t necessarily buy in the marketplace or go short something that’s difficult to short.”

TRS are off balance sheet transactions and investors,normally hedge funds, use it for leverage.
TRS are used as a mechanism to get the benefit of funding arbitrage. Low cost borrowers with large global balance sheets are naturally advantaged as payers in TRS. Synthetic assets are created in the process. Higher cost borrowers, such as hedge funds, enjoy the financing and leverage of the total return transaction. The total return payer pays the total return of a reference security and receives a form of payment from the receiver of the total rate of return. Often payment is a floating rate payment, a spread to LIBOR.

The Goldman deal, which the bank is calling a “covered obligation,” uses a TRS provided by a joint venture between the bank and Mitsui Sumitomo Insurance on a changeable portfolio of fixed income assets. Investors also have recourse to Goldman and Sumitomo in a feature typically found in covered bonds. S&P already gave the bond knows as FIGSCO(Fixed Income Global Structured Covered Obligation)  a AAA rating, but Fitch warns that the deal’s "structural protections and collateralization levels are too low to enjoy such a designation.
With this new Bond offering Goldman is trying solve the inventory financing problem.The deal effectively allows Goldman to source financing for a whole slew of assets all at once, rather than strike individual bilateral deals.