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What is a Liquidation Group?<\/h3>\n
A Clearing Member’s portfolio typically features a diverse structure, size and\/or complexity. Given that complexity, and due to the general handling principles laid out in the default management process, it is usually impossible to liquidate an entire portfolio in one single transaction. Therefore, Prisma introduced the concept of liquidation groups.<\/p>\n
A liquidation group combines cleared products across markets cleared by Eurex Clearing that share similar risk profiles. Liquidation groups serve as a cornerstone of the Prisma portfolio-based risk management method and offer full margin offsetting capabilities per group.<\/p>\n
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- Liquidation groups are pre-defined; they exist irrespective of a clearing member default.<\/li>\n
- Setup of liquidation groups, i.e. what products go into the available groups, is a matter of liquidation process style, risk factor proximity, hedging and pricing ability.<\/li>\n
- Portfolio risk margin offsets are only granted within these pre-defined liquidation groups. <\/li>\n
- Each liquidation group has a fixed holding period that reflects the time estimated to analyze, hedge and auction the respective products. An expected holding period can be between two to five days, depending on the liquidation group, and is the basis for margin calculation at the same time. Equities, for example, are calculated with a four-day holding period (i.e. four-day P&Ls), listed fixed income are calculated with two and OTC products – for regulatory reasons – with five days<\/li>\n<\/ul>\n
![\"\"](\"https:\/\/theotcspace.com\/wp-content\/uploads\/2014\/08\/eurex2.png\")
Figure 2<\/figcaption><\/figure>\n These liquidation groups are a CCP-wide concept; they are not specific to any member portfolio and are a building block for risk management.<\/p>\n
How does the margin modelling actually work?<\/strong>
\nThe development of clearing for OTC products in 2012 brought with it a more sophisticated approach to margin calculation, in particular Value at Risk (VaR). The need for VaR is driven by the long term nature of OTC products, with interest rate swaps reaching out to 50 year terms, potentially making a portfolio more reactive to market conditions and margin requirements than the ETD market going out to around two years. While the older method, the SPAN-like Risk-Based-Margining (RBM) for the listed world was appropriate to calculate ETD exposure, it is no longer sufficient enough to deal with OTC IRS risk. As a consequence, Eurex Clearing decided to introduce a new VaR-based approach and ultimately to use it for all asset classes under the Eurex Clearing umbrella. This was the decision leading to a consolidated margin calculation method, providing a unique approach across product classes and offering margin offsets where there had not been any in the past.<\/p>\nVaR is a statistical method with alternative approaches to practical implementation. The most popular approach is that of Historical Simulation, where the prior history of the market is used to simulate the behaviour of the current portfolio of trades to derive the outcome of market scenarios. With these portfolio simulation scenarios, a CCP then has choices in how to select the amount of margin, one being Worst Case Loss (WCL), another being Expected Shortfall. In order to end up with the most sophisticated and advanced risk calculation method on the market, the Prisma VaR model takes into account multiple factors to calculate margin for a portfolio including:<\/p>\n
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- 750 filtered historical scenarios<\/li>\n
- 250 un-filtered stress scenarios<\/li>\n
- Adjustment for correlation breaks and model error<\/li>\n
- Adjustment for liquidity along the yield curve<\/li>\n
- Adjustment for expiry risk<\/li>\n<\/ul>\n
<\/p>\n
What are the benefits?<\/h3>\n
There are multiple benefits attached to the general setup – both for clearing members and the clearing house alike. <\/p>\n
Clearing members obviously benefit from the fact that with Prisma margins are not calculated on a granular product underlying level anymore but rather on a liquidation group-wide portfolio approach. This alone caters for margin reductions of up to 70% depending on the individual participant’s portfolio structure. For instance, well-balanced, non-directional positions benefit more due to larger offsetting positions.<\/p>\n
With Prisma release 2, and the introduction of listed fixed income products, a whole new level of margin savings is achieved, as members now are able to hold their ETD exposure together with their OTC risk in one single liquidation group. If a member default were to occur, the clearing house would treat this liquidation group as a joint portfolio and hedge and auction it off together. This is the main reason Eurex Clearing can factor in the margin offsetting right from the millisecond members clear a position, be it ETD or OTC.<\/p>\n
Just by activating the cross margin optimiser, Buy Side and Sell Side alike get to potentially save up to 60-70% margin cost due to the fact that, for instance, a Bund future serves as a natural hedge against a 10y interest rate swap in the fixed income liquidation group.<\/p>\n