Cross-margining and collateral savings for cleared derivatives: will the savings really be there?

Part of the marketing pitch from derivatives clearing houses is about the benefits of cross-margining. The broader the product mix that is included in a netting pool, the more advantages will be achieved. The end game is to reduce margin requirements and save on the amount of collateral posted. But there is a problem.

The massive savings attributed to cross margining have been impressive. The CME, in a June, 2013 presentation “Cleared OTC Interest Rate Swaps”, touted cross-margining saying that $1 billion in initial margin savings have been achieved.  In the same paper, the CME showed examples of savings achieved by keeping hedge positions in the same clearing house ranged from 67% to 89%.

These savings work well for hedged portfolios. A 2 year IRS versus a Weighted Eurodollar Strip showed margin of 10 times more when held in different clearing houses and not cross-margined versus held in the same clearing house and netted.

But what some are finding when examining netting benefits for investment portfolios is that the cross-margining savings are not there. Why? Investment managers tend to be directional players. It makes sense since they are investing cash and are long risk in one shape or form. They simply don’t have offsetting positions. Numbers we have been hearing for reductions in margin attributable to cross-margining for investment managers are looking more like 5% to 15%.

The portfolios of derivatives dealers, on the other hand, are largely hedged and perfect for cross-margining and taking advantage of netting advantages. Deutsche Bank, according to a April 29, 2013 post in zerohedge had €776.7 billion in positive derivatives market exposures versus  €756.4 billion in negative market value exposure, for a net of €20.3 billion. Now that is a hedged book.

This will flow down into greater amounts of initial margin and hence more collateral needed as those investors dive deeper into centrally cleared derivatives. The impact may be muted initially as trades are ported to central clearing that were executed at higher interest rates (and are in the money) create margin surpluses in CCPs (although dealers will be on the other side of that)….but it will catch up. Especially if interest rates have turned.

A link to the zerohedge post is here.

A link to the CME paper is here.

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