In a recent DerivSource webinar, the panel discussed the pros and cons of centralising OTC and ETD derivatives and through a single clearer to achieve collateral optimisation as opposed to relying on many clearing providers to achieve risk diversification.
The increase in the collateral burdens as a result of mandated clearing via a central counterparty for OTC derivatives contracts has caused many industry participants to focus on collateral optimisation strategies. The panel of a recent DerivSource webinar weighed up the advantages and disadvantages of going for full collateral optimisation by centralising both OTC and exchange-traded derivatives and via a single clearer as opposed to adopting the alternative strategy where multiple clearing providers are used to achieve risk diversification but at the cost of over collateralisation.
A review of whether the possibility of over collateralisation when using a single clearer versus multiple clearers will have a big impact on a firm depends many factors, such as the size of the portfolio, said Dale Braithwait, Global Head of OTC Clearing Product Development at J.P. Morgan.
He said: “Depending on the size of the portfolio, if it is a relatively small, balanced portfolio I don’t necessarily see having a single strong clearer as a huge issue. It is very important for a large portfolio having the ability to move transactions prior to, but it can mean an over collateralisation, especially in the OTC world.”
One advantage of putting trades together in a single account is that you offset the risks, which also reduces the overall margin the firm would have to pay into the clearinghouse, explains Braithwait. “If you choose multiple clearers, you reduce the ability to consolidate and diversify your portfolio to a particular clearinghouse, therefore potentially increasing the initial margin that you may have to pay,” he said.“Diversifying clearing members will most probably increase your initial margin, while having one clearer may limit your ability to move clearers in the event of a crisis,” Braithwait added.
Portability of positions for cash and collateral is important for market participants seeking to protect themselves against the possibility of a clearing broker failing. Portability of positions alone may not be helpful and it may be necessary to fund additional initial and variation margin with a broker. To guard against this, clients may want to have agreements with multiple clearing brokers.
“Pre-default portability to a chosen clearer within the US construct seems to be a long shot. At the moment, with the way the Futures Commission Merchant (FCM) solutions operate, we think there is an awful lot more work to be done to make post-default processes to a named back up clearer work in practice. This is another thing to consider when choosing whether multiple clearers are necessary,” said Braithwait.
“Our clients definitely want to have more that one broker for several reasons,” said Jonathan Bowler Managing Director 360 EMEA & APAC Business Manager at BNY Mellon. He notes clients can put all the business through one clearing broker and keep the other clearers on alert, or alternatively a firm can split up the portfolio but will then miss some of the synergies available. Additionally, firms may split up by account or legal entity when placing futures or OTCs of the same underlying product with the same clearing broker or even split by currency, so there are several ways to do this.
Bowler said: “Both clearing brokers are working on a day-to-day basis rather than just in the case of portability, pouring lots of trades on one clearing broker, and that position may actually breach their limits. There are lots of ways of looking at this, it offers comfort to know that your clearing brokers are there and ready to take on this business if need be.”
Although not yet mandated CCPs are exploring the benefits of cross margining in OTC and futures markets and the impact on risk, in particular the risk associated with portfolio netting and the impact on margin as highlighted by Chris Zingo, EVP & Head of Global Sales, Calypso.
Zingo asked: “When is this going to happen at the FCM level? In that the end user will have an incentive for more concentration with the FCM to get the benefits of increased flow?”
Braithwait believes this is possible in Europe. He said: “I think in Europe we envisage that it could happen at the FCM …It is possible that they would be able to offset it with bilateral, non-cleared trades on behalf of their clients and offer reduced collateral.”
However, such an arrangement may not be permissible in the US under the regulation.
The regulations from the Commodities Futures Trading Commission (CFTC) on the OTC side are pretty clear in that clearing members can not take liens on the collateral itself, making it difficult for them to offer cross collateralisation, explains Braithwait. The CFTC recently indicated that these rules may be relaxed, but bifurcating risks in multiple pools will inevitably lead to higher margins.
He said: “This is why a number of CCPs are now looking to offer cross collaterlisation between futures and swaps. On the credit default swap (CDS) side, Intercontinental Exchange (ICE) recently announced that they would be putting European CDS into their US clearinghouse. Very soon I think you will see CCPs offering these offsets rather than the clearers and FCMs via intermediation.”
As the industry moves towards centralised clearing, integration of risk management, segregation of assets and the portability of not just positions but also collateral and margin will all be important technological challenges. It is hoped by market participants that regulation will ensure a consolidation of margining standards among CCPs across the industry.
Webinar Recording:
https://deriv.webex.com/deriv/lsr.php?AT=pb&SP=EC&rID=1778707&rKey=C550C98B0F7CFDBB
