Finadium Research Report

Central Credit Counterparties, Margin and the Challenge of Collateral Management

Finadium
March 2011

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New rules for central credit counterparties (CCPs) in OTC derivatives promise to cause significant disruption for collateral management. Since the collapse of Lehman Brothers International (Europe), collateral management has been faced with a series of complex challenges and new regulations. Dodd-Frank and Basel III continue to increase the demands on bank balance sheets. Following the publications of CCP margin requirements and several regulatory documents on setting collateral limits, it is now possible to begin to understand the ramifications of these regulations and market trends on the business of collateral management.

Collateral management is far from straight-forward, even today. A diversity of end-clients including corporations, insurance companies and sovereign entities mean that different levels of risk are assumed for each type of trade with each counterparty. While banks have come to understand these risks in the bilateral market, both they and their clients may be surprised by the extent of the changes required using multiple CCPs to clear trades across multiple jurisdictions. Bank exposure models in particular are challenged by the amount of new netting required by these new trading partners.

This report analyzes many of the changes coming to collateral markets with the growth of CCPs for OTC derivatives. We focus on the critical topics of risk waterfall models, how client funds are segregated or not from other collateral pools, the need for banks and end-clients to rewrite collateral agreements, and the extent of collateral that will suffer liquidity gaps as a result of new CCP rules.

This report should be read by banks, asset managers, insurance companies, plan sponsors, technology firms and others affected by new rules for posting margin on central credit counterparties.

This report is 23 pages with 6 exhibits.

TABLE OF CONTENTS
■ Executive Summary

■ Assessing the Landscape for OTC Derivative CCPs
– Dodd-Frank, MiFID II and the CPSS-IOSCO Recommendations

■ Netting and Managing Collateral Funding Levels
– Options for Collateral Segregation
– Whither Rehypothecation

■ Client Agreements and Mismatches in Posting Collateral
– Where Will Collateral Come From?

■ Liquidity and Frozen Collateral in the CCP Model

■ Higher Costs, Fewer Choices

■ About the Authors

■ About Finadium

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