Segregation models and Eurex
In Risk Magazine an article (here – subscription required) covers the launch of an IRS clearing service in late March by Eurex. The main thrust of the article is a debate about segregation models. The Eurex goal is to provide the 'full segregation model' (see below), as the ultimate model of providing clients with protection. The debate in the Risk article, is that providing each client with their own account for assets, ramps up the number of open accounts, with all the related maintenance. Both Kim Taylor at CME and ISDA suggest that the fully segregated model is expensive to operate (although they don't say if that model is actually providing better protection), Eurex counter by saying they have the infrastructure to operate thousands of accounts, with little incremental cost – so stick that in your pipe, as it were.
Current 'futures omnibus' model
The original of the word omnibus is this: early 19th cent.: via French from Latin, literally ‘for all’, dative plural of omnis. The 'all' in this context is the clients of an FCM in the US, the idea that the risk across the clients are mutualised, and losses shared. In this model, the trades from two or more Funds / Clients, are margining discretely, but the resulting margin requirements are aggregated via the FCM, who calls each Fund for their contribution to the asset pool, but nets the flows of assets between itself and the CCP. The FCM is also free to ask for more margin than the CCP requires, which can be a source of profit. The article by Craig Pirrong (below) walks through two scenarios comparing the outcome of the omnibus and the segregated model, worth a read.
Full segregation – Eurex model
The Eurex proposal (available at the end of March) will provide full segregation for a fund in all respects. In all cases the CCP (Eurex) would have access to the assets of the Funds to settle any default.
El Soc – the mexican way
The model supported by ISDA, ICE, CME, LCH and others is Legal Segregation, Operational Co-mingling (LSOC), a compromise where the collateral assets are stored in a single account, but the record keeping distinguishes which asset belongs to which fund. The FCM may also use an account to pass through the margin assets, but holding them at the CCP avoids any issues about access to assets should the FCM default itself.
A final twist on all these scenarios, is to introduce a custodian of the assets, common across the Fund, FCM and CCP. In this case the transfer of assets would be book transfer between accounts. The Fund believes that it's asset are safeguarded by an independent third party, but of course the CCP & FCM must have access to the account to make the transfers. Introducing a custodian will then attract further processing costs, and legal relationships, not everyone believes this step is necessary.
- Reuters article: http://www.complinet.com/dodd-frank/news/articles/article/ifr-the-battle-over-margin-segregation.html
- Craig Pirrong, argues for co-mingling: http://streetwiseprofessor.com/?p=5227
- ISDA feedback paper with economic impact estimates: http://www.isda.org/speeches/pdf/CFTC-ANPR-Protection-for-Cleared-011811.pdf
- Markets Media: http://marketsmediaonline.com/buy-side-seeks-wider-margin-choice/
- Linklaters commentary on the CFTC rules: PDF
- ICE CDS client clearing overview, omnibus: https://www.theice.com/publicdocs/ice_trust/ICE_CDS_Buyside_Clearing_Overview.pdf
If anyone sees errors above, do let me know, it's a complex subject, and despite researching thoroughly, clarity isn't easy to find.