The use of collateral and the implementation of collateral management techniques have changed dramatically with the evolution of financial regulatory reform. As mandatory CCP clearing for standardized products have come into effect, bilateral margining for non-cleared swaps remains uncertain. While margin requirements are driven by each CCP’s individual methodology – regulators have proposed even greater and more stringent margin and collateral requirements for non-cleared OTC trades, where both initial and variation margin must be posted. As part of this change, managing margin requirements in careful balance with collateral optimization techniques remain two of the most important issues impacting today’s derivative marketplace.
In part one of this two part blog series, Anna Barbashova, VP in the Numerix Client Solutions Group breaks down today’s collateral challenge, addressing the debate around collateral shortage, sourcing collateral and cost mitigation. In part two we’ll discuss how today’s derivative market participants are meeting these challenges with innovative solutions.
Significant analysis is required to calculate the CVA of a counterparty position before and after moving trades to a CCP, and calculating the CCP specific initial margin requirements of trades must be considered in the context of the CSA agreement which regulates the collateral of derivatives transactions. Beyond the direct impacts, what are complex interdependencies between various valuations adjustments and funding costs?
As your question states – if central clearing is not taking place, trades are conducted with a counterparty bilaterally and an array of pricing and risk adjustments or “xVAs” have to be incorporated into the valuation. These include CVA, DVA and also FVA. Essentially encompassing your cost of funding, posting collateral to your counterparty does not come free. We should note:
- As a result of regulation trades that are not centrally cleared are subject to higher capital requirements.
- Alternatively, when you move your trades to an exchange or clear OTC derivatives through CCPs you have to post initial margin and variation margin throughout the life of the trade.
- In addition, CCPs are asking for highly liquid collateral such as cash or cash equivalent assets which comes at a higher cost.