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Central Counterparties

Mandatory Central Clearing and Initial Margin Requirements for OTC Derivatives
The Wiley Finance Series 1. Aufl.

von: Jon Gregory
63,99 €
Verlag:	Wiley
Format:	EPUB
Veröffentl.:	25.06.2014
ISBN/EAN:	9781118891582
Sprache:	englisch
Anzahl Seiten:	336

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Beschreibungen

Titelbeschreibung

Practical guidance toward handling the latest changes to the OTC derivatives market Central Counterparties is a practical guide to central clearing and bilateral margin requirements, from one of the industry's most influential credit practitioners. With up-to-date information on the latest regulations imposed after the global financial crisis, this book covers the mechanics of the clearing process and analyses the resulting consequences. Detailed discussion explains the ways in which the very significant clearing and margining rules will affect the OTC derivatives market and the financial markets in general, with practical guidance toward implementation and how to handle the potential consequences. Over-the-counter derivatives were blamed by many for playing a major role in the 2007 financial crisis, resulting in a significant attention and dramatic action by policymakers, politicians, and regulators to reduce counterparty credit risk which was seen as a major issue in the crisis. The two most important regulatory changes are the mandatory clearing of standardised OTC derivatives, and the requirements for bilateral margin posting in non-standard OTC contracts. Central Counterparties is a complete reference guide to navigating these changes, providing clarification and practical advice. <ul> <li>Review the mitigation of counterparty credit risk with the historical development of central clearing</li> <li>Clarify the latest regulatory requirements imposed by Dodd-Frank, EMIR, Basel III and more</li> <li>Learn the mechanics of central clearing, with special attention to complex issues such as margin calculations, the loss waterfall, client clearing and regulatory capital rules</li> <li>Gain insight into the advantages and disadvantages of clearing and bilateral margin requirements, and the potential issues that arise</li> </ul> As the clearing and margining mandates are phased in, the associated costs will be severe enough to dramatically shift the topology of the financial markets and transform the nature of risk. Central Counterparties provides the information, clarification and expert insight market practitioners need to get up to speed quickly.

Inhaltsverzeichnis

Acknowledgements xv Part I: Background 1 1 Introduction 3 1.1 The crisis 3 1.2 The move towards central clearing 4 1.3 What is a CCP? 6 1.4 Initial margins 7 1.5 Possible drawbacks 8 1.6 Clearing in context 9 2 Exchanges, OTC Derivatives, DPCs and SPVs 11 2.1 Exchanges 11 2.1.1 What is an exchange? 11 2.1.2 The need for clearing 12 2.1.3 Direct clearing 12 2.1.4 Clearing rings 13 2.1.5 Complete clearing 14 2.2 OTC derivatives 16 2.2.1 OTC vs. exchange-traded 16 2.2.2 Market development 18 2.2.3 OTC derivatives and clearing 19 2.3 Counterparty risk mitigation in OTC markets 20 2.3.1 Systemic risk 20 2.3.2 Special purpose vehicles 21 2.3.3 Derivatives product companies 22 2.3.4 Monolines and CDPCs 23 2.3.5 Lessons for central clearing 24 2.3.6 Clearing in OTC derivatives markets 25 2.4 Summary 26 3 Basic Principles of Central Clearing 27 3.1 What is clearing? 27 3.2 Functions of a CCP 27 3.2.1 Financial markets topology 28 3.2.2 Novation 28 3.2.3 Multilateral offset 29 3.2.4 Margining 30 3.2.5 Auctions 30 3.2.6 Loss mutualisation 31 3.3 Basic questions 31 3.3.1 What can be cleared? 31 3.3.2 Who can clear? 33 3.3.3 How many OTC CCPs will there be? 35 3.3.4 Utilities or profit-making organisations? 36 3.3.5 Can CCPs fail? 36 3.4 The impact of central clearing 36 3.4.1 General points 36 3.4.2 Comparing OTC and centrally cleared markets 37 3.4.3 Advantages of CCPs 37 3.4.4 Disadvantages of CCPs 38 3.4.5 Impact of central clearing 38 4 The Global Financial Crisis and the Clearing of OTC Derivatives 41 4.1 The global financial crisis 41 4.1.1 Build-up 41 4.1.2 Impact of the GFC 41 4.1.3 CCPs in the GFC 42 4.1.4 LCH.Clearnet and SwapClear 42 4.1.5 Lehman and other CCPs 43 4.1.6 Responses 44 4.1.7 Objections 45 4.2 Regulatory changes 46 4.2.1 Basel III 47 4.2.2 Dodd–Frank 48 4.2.3 EMIR 48 4.2.4 Differences between the US and Europe 49 4.2.5 Bilateral margin requirements 50 4.2.6 Exemptions 52 4.3 Regulation of CCPS 53 4.3.1 Problems with mandates 53 4.3.2 Oversight 53 4.3.3 CCPs and liquidity support 55 Part II: Counterpa rty Risk, Netting and Margin 57 5 Netting 59 5.1 Bilateral netting 59 5.1.1 Origins of netting 59 5.1.2 Payment netting and CLS 60 5.1.3 Close out netting 60 5.1.4 The ISDA Master Agreement 62 5.1.5 The impact of netting 62 5.1.6 Netting impact outside OTC derivatives markets 63 5.2 Multilateral netting 65 5.2.1 The classic bilateral problem 65 5.2.2 Aim of multilateral netting 65 5.2.3 Trade compression 66 5.2.4 Trade compression and standardisation 68 5.2.5 Central clearing 70 5.2.6 Multilateral netting increasing exposure 71 6 Margining 75 6.1 Basics of margin 75 6.1.1 Rationale 75 6.1.2 Title transfer and security interest 76 6.1.3 Simple example 76 6.1.4 The margin period of risk 77 6.1.5 Haircuts 78 6.2 Margin and funding 79 6.2.1 Funding costs 79 6.2.2 Reuse and rehypothecation 80 6.2.3 Segregation 82 6.2.4 Margin transformation 84 6.3 Margin in bilateral OTC derivatives markets 84 6.3.1 The credit support annex (CSA) 84 6.3.2 Types of CSA 85 6.3.3 Thresholds and initial margins 86 6.3.4 Disputes 87 6.3.5 Standard CSA 88 6.3.6 Margin practices in bilateral OTC markets 89 6.4 The risks of margining 92 6.4.1 Margin impact outside OTC derivatives markets 92 6.4.2 Operational risk 93 6.4.3 Liquidity risk 93 6.4.4 Funding liquidity risk 94 6.4.5 Segregation risk 94 6.5 Regulatory margin requirements 94 6.5.1 Background 94 6.5.2 General requirements 95 6.5.3 Threshold 97 6.5.4 Segregation and rehypothecation 98 6.5.5 Initial margin methodologies 99 6.5.6 Non-netting across asset class 101 6.5.7 Haircuts 101 6.5.8 Criticisms 102 7 Counterparty Risk in OTC Derivatives 105 7.1 Introduction 105 7.1.1 Background 105 7.1.2 Origins 106 7.1.3 Settlement and pre-settlement risk 106 7.2 Exposure 108 7.2.1 Definition 108 7.2.2 Mark-to-market and replacement cost 110 7.2.3 Non-margined exposure 110 7.2.4 Margined exposure 111 7.3 Valuation adjustments 114 7.3.1 CVA 114 7.3.2 Impact of margin on CVA 114 7.3.3 DVA and FVA 115 7.3.4 Wrong-way risk 117 7.3.5 The balance between counterparty risk and funding 118 Appendix 7A: Simple formula for the benefit of a margin agreement 119 Part III: Structure and Mechanics of Clearing 121 8 The Basics of CCP Operation 123 8.1 CCP setup 123 8.1.1 CCP ownership 123 8.1.2 Fees 124 8.1.3 What needs to be cleared? 125 8.1.4 Important OTC derivative CCPs 125 8.2 CCP operation 127 8.2.1 CCP members and non-members 127 8.2.2 Process of clearing 129 8.2.3 Compression 130 8.2.4 Requirements for products to be cleared 131 8.3 CCP risk management 133 8.3.1 Overview 133 8.3.2 Membership requirements 135 8.3.3 Margining 136 8.3.4 Margin interest rates 137 8.4 Default management 139 8.4.1 Declaring a default 139 8.4.2 Close out process 140 8.4.3 Auction 140 8.4.4 Client positions 141 8.4.5 Loss allocation 141 8.4.6 Wrong-way risk 143 8.5 CCP linkage 143 8.5.1 Interoperability 143 8.5.2 Participant and peer-to-peer models 144 8.5.3 Mutual offset 146 8.5.4 Cross-margining 146 9 Margin and Default Fund Methodologies 149 9.1 Variation margin 149 9.1.1 Valuation 149 9.1.2 Frequency of margin calls 150 9.1.3 Convexity and price alignment interest 150 9.1.4 Variation margin and liquidity risk 151 9.2 Initial margin 152 9.2.1 Close out period 152 9.2.2 Coverage 154 9.2.3 Linkage to credit quality 155 9.2.4 Haircuts and non-cash margins 156 9.2.5 The SPAN methodology 157 9.3 VAR and historical simulation 158 9.3.1 Value-at-risk and expected shortfall 158 9.3.2 Historical simulation 161 9.3.3 Look-back periods 161 9.3.4 Relative and absolute scenarios 161 9.3.5 Procyclicality 162 9.4 Initial margins for OTC derivatives 164 9.4.1 Requirements for initial margin approach 164 9.4.2 OTC CCP initial margin approaches 165 9.4.3 Competition 167 9.4.4 Computation considerations 168 9.4.5 Standard initial margin model (SIMM) 169 9.5 Cross-margining 170 9.5.1 Rationale 170 9.5.2 Cross-margining within a CCP 171 9.5.3 Exchange-traded and OTC products 172 9.5.4 Cross-margining between CCPs 173 9.5.5 Methodologies for cross-margining 174 9.6 Default funds 174 9.6.1 Coverage of initial margin 174 9.6.2 Role of the default fund 175 9.6.3 Default fund vs. initial margin 176 9.6.4 Size of the default fund 177 9.6.5 Splitting default funds 178 10 The Loss Waterfall and Loss Allocation Methods 181 10.1 Potential CCP loss events 181 10.1.1 Review of the loss waterfall 181 10.1.2 Clearing member default losses 183 10.1.3 Non-default related losses 184 10.2 Analysis of CCP loss structure 184 10.2.1 Second loss exposure 184 10.2.2 The prisoner’s dilemma 185 10.2.3 Unlimited default fund contributions 186 10.2.4 Default fund tranches 186 10.3 Other loss allocation methods 187 10.3.1 Variation margin gains haircutting 188 10.3.2 Partial tear-up and forced allocation 189 10.3.3 Complete tear-up 191 10.3.4 Other methods 192 10.3.5 Impact on client trades 192 10.3.6 Methods used in practice 193 10.4 Capital charges for CCP exposures 194 10.4.1 Qualifying CCPs 194 10.4.2 Trade and default fund related exposures 195 10.4.3 Capital requirements for trade exposures 196 10.4.4 Capital requirements for default fund exposures 197 10.4.5 Method 1 (interim rules) 198 10.4.6 Method 2 (interim rules) 199 10.4.7 Final rules 200 10.4.8 Example and discussion 200 10.4.9 Client clearing and bilateral aspects 201 Appendix 10A: Technical details on the interim and final rules 203 11 Client Clearing, Segregation and Portability 207 11.1 Operational aspects 207 11.1.1 General setup 207 11.1.2 Principal-to-principal model 208 11.1.3 Agency model 209 11.1.4 Margin requirements between client and CCP 209 11.1.5 Client point of view 210 11.1.6 Clearing member point of view 212 11.1.7 Portability 213 11.2 Segregation, rehypothecation and margin offset 215 11.2.1 The need for segregation 215 11.2.2 The difference between variation and initial margins 216 11.2.3 Net and gross margin 218 11.2.4 Net margin and portability 218 11.3 Methods of segregation 220 11.3.1 Omnibus segregation 221 11.3.2 Individually segregated accounts 222 11.3.3 LSOC 223 11.3.4 Example 226 11.3.5 The liquidity impact of segregation 227 11.4 Regulatory requirements 228 11.4.1 CPSS-IOSCO 228 11.4.2 Dodd–Frank/CFTC 228 11.4.3 EMIR 229 11.4.4 Basel III and capital implications 229 Part IV: Analysis of the Impa ct and Risks ofCe ntral Clearing 231 12 Analysis of the Impact of Clearing and Margining 233 12.1 The clearing landscape 233 12.1.1 Bilateral vs. central clearing 233 12.1.2 How much is currently cleared? 236 12.1.3 What should be cleared? 236 12.1.4 The number of CCPs 238 12.1.5 Choosing a CCP 239 12.2 Benefits and drawbacks of OTC clearing 240 12.2.1 Advantages 240 12.2.2 Disadvantages 241 12.2.3 Homogenisation 242 12.2.4 Moral hazard and informational asymmetry 243 12.3 Side effects 243 12.3.1 Futurisation 243 12.3.2 Regulatory arbitrage 244 12.3.3 Netting optimisation 246 12.3.4 Re-leveraging 246 12.3.5 Pricing behaviour 247 12.4 Is there a better idea? 248 13 The Cost and Impact of Clearing and Margining 251 13.1 Overview 251 13.1.1 Strengths and weaknesses of margin 251 13.1.2 Variation margin 252 13.1.3 Initial margin 253 13.2 Examples 254 13.2.1 American International Group (AIG) 254 13.2.2 The BP Deepwater Horizon oil spill 254 13.2.3 Ashanti 255 13.3 The cost of margining 256 13.3.1 Margin and funding 256 13.3.2 How expensive? 257 13.3.3 Variation margin 259 13.3.4 Initial margin 261 13.3.5 Converting counterparty risk to liquidity risk 261 13.3.6 Manifestation of funding liquidity risks 263 13.4 Implications 264 14 Risks Caused by CCPs 265 14.1 Overview 265 14.1.1 General risks created by CCPs 265 14.1.2 Risks for clearing members 266 14.1.3 Risks for non-clearing members 266 14.2 Historical CCP failures and near misses 267 14.2.1 New York Gold Exchange Bank (1869) 267 14.2.2 Caisse de Liquidation (1974) 267 14.2.3 COMEX (1980) 268 14.2.4 Commodity Clearing House (1983) 268 14.2.5 Hong Kong Futures Exchange and 1987 crash 269 14.2.6 BM&FBOVESPA (1999) 270 14.2.7 Lessons from past CCP failures 270 14.3 Important considerations 271 14.3.1 Hindsight bias 271 14.3.2 Race to the bottom? 272 14.3.3 Distributive effects and the big picture 272 14.3.4 Mutualisation and CCPs as CDOs 273 14.3.5 The need for margin 274 14.3.6 The impact of mandatory clearing 275 14.3.7 Transparency 275 14.3.8 Interconnectedness 276 14.4 Risks faced by CCPS 276 14.4.1 Default risk 276 14.4.2 Non-default loss events 277 14.4.3 Model risk 278 14.4.4 Liquidity risk 278 14.4.5 Operational and legal risk 279 14.4.6 Other risks 279 14.5 Keeping CCPs safe 280 14.5.1 Will they be allowed to fail? 280 14.5.2 Governance 281 14.5.3 Disclosure 282 14.5.4 Insurance schemes 282 15 The Future Impact on Financial Markets 283 15.1 Regulatory change 283 15.2 The impact 284 15.3 Good or bad? 285 Glossary 287 References 293 Index 299

Autorenportrait

DR JON GREGORY is a partner at Solum Financial Partners LLP and specialises in counterparty risk and CVA related consulting and advisory projects. He has worked on many aspects of credit risk in his career, being previously with Barclays Capital, BNP Paribas and Citigroup. He is author of the book Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets Second Edition. Jon holds a PhD from Cambridge University.

Back cover copy

Central Counterparties Mandatory Clearing and Bilateral Margin Requirements for OTC Derivatives The Global Financial Crisis, from 2007 onwards, illustrated the inherent weaknesses in the global financial system and some of their causes. In particular over-the-counter (OTC) derivatives were blamed by many for partially causing and catalysing the crisis. Not surprisingly, this has led to dramatic action from politicians, policymakers and regulators in relation to OTC derivative markets. Two of the most important changes are the mandatory clearing of standardised OTC derivatives and the requirements for bilateral margin posting in non-standard OTC contracts. Both clearing and margining mandates will be effectively phased in from 2014 and the associated costs will be severe. These regulatory changes are therefore going to create a dramatic shift in the topology of financial markets, together with a significant reallocation of counterparty and systemic risks. Knowledge of the subject is an important consideration for all financial institutions whether they are CCP members, clear trades indirectly or find themselves subject to bilateral margin requirements. Central Counterparties: Mandatory Clearing and Bilateral Margin Requirements for OTC Derivatives explains the central clearing of OTC derivatives and the associated bilateral margin requirements. The book provides a historical perspective of central clearing as it developed with derivative exchanges in order to mitigate counterparty credit risk. The regulatory requirements (Dodd-Frank, EMIR, Basel III) being imposed since the global financial crisis are defined and discussed. The mechanics of central clearing are described including operational aspects, initial margin and default fund calculations, loss waterfalls and allocation methods. Client clearing is discussed, in particular giving detail on margin segregation and portability methods. An assessment is made throughout of the advantages and disadvantages of clearing and margining requirements, including potential issues such as funding liquidity risk, operational risk and wrong-way risk. The book is unique and covers the regulatory requirements together with the practical implementation details and the potential impacts and consequences. It is an invaluable and complete reference guide for any market practitioner, policy maker, academic or student with responsibility or interest in the area of OTC derivatives.