Finadium: Guide to Margining for Cleared Swaps vs. Futures

Finadium has released a guide to understanding margin rules for cleared OTC swaps, non-cleared swaps, swap futures and standard futures. This guide is intended for market professionals needing a briefing on the main issues for investments and product development.

How risk is managed and initial margin calculated are critical to understanding the safety of cleared swaps and futures products. Our new report, “A Guide to Margining for Cleared OTC Swaps vs. Margining for Futures,” reviews the similarities and important differences to risk management models including SPAN, Historical Value-at-Risk (HVAR), omnibus vs. LSOC accounts and liquidation models.

Central counterparties (CCPs) and Derivatives Clearing Organizations (DCOs) now appear to be single points of failure in financial markets. While both have extensive risk management systems designed to make their processes robust, differences in risk waterfalls play an important part in distinguishing cleared swaps from futures and hybrid swap futures.

In a futures contract, initial margin (IM) is put up on every trade based on calculations made by the exchange. Trades are marked to market and a portfolio value calculated. Each trade is subject to margin maintenance triggers – if a trade goes below a certain value then additional margin must be deposited to bring the margin value back to its initial level. Exchanges net the exposure on a Futures Clearing Merchant (FCM) level, who in turn do the same on a client-by- client basis. FCMs can ask for margin that exceeds what the Derivatives Clearing Organization (DCO) requires. Should a client of the FCM default on a margin payment, the trades are closed out. Any losses follow the risk waterfall.

In cleared OTC swaps, there are similarities to the futures model. A central counterparty (CCP) faces the Clearing Member and margin is based on the portfolio of trades outstanding. The Clearing Member then decomposes the trades by client and calculates margin due or payable, cross-margining within portfolios. Each CCP imposes one set of rules on how margin is determined and what collateral is eligible although Clearing Members may be mandated by regulators to charge their clients more than what they pay the CCP.

This report has been written for portfolio and risk managers looking for a comparable analysis of how cleared and non-cleared swaps are similar or vary from futures, as well as what is at stake. The differences in risk models, required margin and liquidation practices may help managers to decide which products are best suited for their or their clients’ investments.

This analysis is a technical companion to Finadium’s March 2013 report, The Futurization of the Swaps Market: Players, Products and Collateral.

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