Cross product margining is increasingly seen as an essential part of optimising initial margin requirements and funding costs. In a DerivSource Q&A, Isabelle Blanche, fixed income sales, derivatives, funding & financing, at Eurex discusses the value cross product margining delivers to its members and end clients during current times of market volatility, increasing margin requirements, and when capital efficiency is paramount.
Q. Looking at the markets today, what are the drivers behind the growing value of cross product margining?
A. Various factors in the market are behind a growing interest in cross product margining. We have seen significant margin increases due to increased market volatility, particularly in fixed income markets. This trend combined with anti-procyclicality measures through higher margin floors, will likely lead to a situation that margin requirements will remain elevated for some time. Consequently, rising funding costs are driving the increased need for margin optimisation.
Additional regulatory requirements also play a role. Both the expected end of the central clearing exemption for pension funds in Europe and the nearing of the final deadline (Phase 6) for the Uncleared Margin Rules (UMR) are driving derivatives volumes, which increases the need for firms to post more Initial Margin (IM). As a result, buy-side firms are gradually looking to optimise margin management practices to avoid spikes in funding costs.
Market drivers such as the changing interest rate environment are also powering an uptick in derivatives clearing volumes from the sell side too. Specifically, open interest, liquidity and volumes are increasing for Euro-denominated interest rate swaps as well as for interest rate futures at Eurex, offering more opportunities to net exposures.
Also, the ongoing concern for geopolitical risks has resulted in a greater interest in reducing cross border risks. This and the changing interest rate environment shifted the focus from cross currency offsets to interconnected products within a currency where the correlation is higher, and therefore can deliver better risk offsets and margin savings.
Both market and regulatory changes have accelerated the need to actively manage margin requirements with risk offsetting tools, such as cross product margining, to achieve efficiencies and cost savings.
Q. What have been the biggest challenges to implementing cross product margining?
A. For the past few years, liquidity has been built up to reach a level where clients do not need to face the decision between margin benefits vs liquidity risks in swaps. Additional liquidity added by banks and end-clients will further enhance the optimisation potential of cross product margining and capitalisation benefits as volumes grow.
Implementing cross product margining requires some centralisation to post-trade activities across swaps and futures for both the buy and sell side. Many firms appreciate the business case for cross product margining, but changing their setup requires technology expertise and resources. However, those used to be scarce mainly due to regulatory driven mandatory change initiatives.
Technology integration also poses a challenge. Many firms use specific front, middle and back-office systems for their futures trading business and when they incorporate swaps trading into the clearing operational environment, they often used a separate set-up. lt is difficult to implement cross product margining when having to reconcile positions and manage collateral across two different back-office infrastructures.
Some clearing members have had to harmonise their back-office platforms between futures and swaps before they could support cross product margining, and this took some time. Systems and operational processes supporting the ability to optimise portfolios and collateral were initially not widely available, however, there are now elaborate solutions from vendors. Also, many buy-side firms now have specialist funding teams that are focused on managing margins and collateral more efficiently given the market and regulatory drivers mentioned previously.
Q. What are the next steps that need to be taken to support uptake of cross product margining services generally?
A. Eurex can assist both the clearing brokers and end clients in exploring various strategies for optimisation that cross product margining can deliver.
In terms of uptake of Eurex’s cross product margining service, we have several clearing brokers live with clients using it. Additional brokers are finalising their implementations to go live with a client in the first half of 2022 and more are expected to follow. Several brokers are already using the service for their house trading accounts.
Clearinghouses, like Eurex Clearing, will play a key role in providing infrastructure across risk, product, technology and liquidity. It is Eurex’s ambition to build a comprehensive cross-asset clearing model, that is focused on robust and optimised risk, product and technology to help its end-clients and members to achieve capital and margin efficiencies as well as lower funding costs that come with cross product margining.
Recently, Eurex has refined the cross-product margining algorithm to better capture the offsetting relationship of the combined portfolios between swaps and futures, further improving margin efficiencies.
Additionally, Eurex created an on-premise API to display the potential savings by the combined clearing of swaps and futures. Eurex’s ambition is to lead innovation by bringing swaps, futures, and repos into the same margin pool to maximise optimisation potential.
*To hear more about this topic, please join Isabelle Blanche in an upcoming panel on cross product margining as part of Eurex’s Derivatives Forum.
