The Cost of Collateral Management in a New CCP Environment
Prof Craig Pirrong offers his take on the biggest concerns for cost and collateral management in 2012 and as the push to central clearing progresses. Comments based on “The Cost of Clearing” podcast in November 2011.
There is going to be tremendous pressure in 2012 to try to find ways to economise margin management. The biggest change with collateral management and central clearing is that firms that previously have not been required to post margin are going to be required to do so. And if they are trading in a variety of instruments that are cleared through multiple clearing houses, substantial sums of capital will be tied up in margin.
All the potential ways in which firms will try to economise margin management will require a lot of coordination among central counterparties (CCPs) including cross margining across different clearing houses. This means if a firm has risk positions that are off-setting or hedging one another but are housed in different clearing houses, it can it take advantage of that through some sort of cross-margining arrangement to reduce the amount of margin to reflect the amount of overall risk that it brings into the system as opposed to the risk associated with the individual legs of the transactions.
Interoperability is also a potential way of economising margin at the CCP level but I think that is likely to be a non-starter because of the reluctance of CCPs to accept risk from other CCPs.
The cost of margin management will also be affected both directly and indirectly by how that margin is held. Segregation is a collateral issue that is also going to be brought back to the fore after the MF Global problems of late 2011 and it will be a very important issue going forward.
There will also be tremendous demand for liquidity in order to meet the increased collateral and margining needs. Questions around what kind of assets will be usable as collateral and what sort of services big financial intermediaries will offer their customers to try to transform non-CCP eligible assets into eligible collateral for posting to the CCPs still need to be answered. Also, I think CCPs are going to be under tremendous pressure to expand the set of assets that they are willing to take as collateral and that raises all sorts of risk issues.
In short, as we start pulling on this collateral management string, all the issues and risks that arise from this move to central clearing and the initial margin requirements will reveal themselves. This year many of these issues will come to the fore for the industry at large.
Professor of Finance and Energy Markets Director of the Global Energy Management Institute at the Bauer College of Business, University of Houston.
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