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August 19, 2014

Cross Margining at Eurex Clearing | An Explanation | Part 3 of 3

The final part of this three part article on cross-margining.

Part 1 of this article appeared here: http://www.theotcspace.com/2014/08/05/cross-margining-eurex-clearing-explanation-part-1-3, part 2 appeared here and this third part completes the article.

Cost benefits and margin simulations

To validate the approach to combining OTC and ETD products, Eurex Clearing has created a series of synthetic sample portfolios with input from external parties; to ensure that this combined approach does produce real cost savings.  The details of these sample portfolios, and extensive background information on how the savings are realised, are available from Eurex Clearing by request.

Eurex Clearing’s study “The Future of Central Clearing – Maximizing capital and cost efficiency through an integrated cross-product CCP clearing service’ (http://www.eurexclearing.com/blob/clearing-en/51430-901130/890470/5/data/otc_clear_the_future_of_central_clearing_wyman_study.pdf) also shows, that depending on the structure of the participants' portfolios there could be  considerable margin saving benefits by clearing both ETD and OTC positions at Eurex Clearing rather than having the ETD positions in clearing house A and the OTC positions in clearing house B. The latter alternative would obviously lack the offsetting capability within one clearing house and would not lead to cross margin effects of up to 70% that are possible at Eurex Clearing.

Eurex Clearing worked with inter-dealer brokers and other market participants to create a realistic synthetic portfolio of rate swaps and futures, to test the new margin approach. The economic analysis covered not just initial margin but capital, funding, CVA, fees and the default fund to achieve a holistic understanding of each scenario. The simulation was performed three times, once each for:

  • Non-cleared bilateral OTC and cleared ETD = “bilateral”
  • Cleared OTC and ETD without any cross margining = “baseline CCP”
  • Cleared with the Eurex Clearing Prisma method with offsets between OTC and ETD = “Eurex Clearing”

The sell-side case studies consider a global dealer (investment bank) and a regional bank, both with sizeable OTC interest rate derivatives portfolios, including client clearing activities. The below picture summarizes the cost savings of central clearing, taking into account capital and funding costs as well as CVA, assuming the complete OTC interest rate derivatives portfolios is moved from a bilateral with initial margin to a central clearing model. In order to account for differences in efficiencies between CCPs, the savings are shown for a baseline CCP with product siloes and narrow collateral spectrum compared to an integrated cross-product CCP with a broad collateral spectrum such as Eurex Clearing, quantifying the additional cost efficiencies outlined above.

Figure 6

 

 

 

Figure 7
Figure 8

The buy-side case studies consider the economics of a range of buy-side firms including a fixed income mutual fund and a fixed income hedge fund. As mutual and hedge funds do not have to hold regulatory capital and make credit value adjustments, the economics are entirely driven by funding costs for initial margin, variations in bid-ask spreads and client clearing fees. It is assumed that both funds do not hold collateral eligible on a baseline CCP (with a narrow collateral spectrum), and incur funding costs as they need to upgrade collateral when moving onto the baseline CCP. The funds also need to pay fees to the clearing brokers. The additional funding costs and clearing fees, however, may be more than offset by reduced mark-ups on bid-ask spreads charged by the funds’ trading counterparties, since cost structures of the counterparty banks are lower of centrally cleared versus bilateral transactions.

For further information please refer to the related study following this link: Free download from www.eurexclearing.com

What now?

This article provides an overview of the complex approach needed to enable cross-margining of OTC and ETD positions, Eurex has much more material which goes into more detail, including Prisma, the selection of ETD positions, the sample portfolios and details on the economic cost benefits of this new innovation. All interested parties are welcome to get in contact with Eurex Clearing to discuss how this approach would benefit market participants’ portfolios.

Eurex Clearing is also offering to run further margin simulations followed by extensive clearing cost analyses in order to provide full cost saving transparency to all interested firms and individuals.

Please get in contact with Eurex Clearing Relations via my profile on this site or click here (and use the email address in the icon on the right)


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