Enacting regulatory reform on the centralised clearing of over-the counter (OTC) derivatives is far easier than actually implementing the changes, concludes a report issued by Advent Software.
The group’s 12-page report, entitled ‘The impact of centralised derivatives clearing’ discusses how the new market structure will affect both buy- and sell-side participants in the derivatives market.
The authors suggest that larger funds can no longer expect preferential treatment that typically meant once-a-month calls and it appears that clearing houses, in contrast to the bilateral trading arrangement, are likely to take a harder line on margin amounts and the timing of transfers. The report also examines ways that firms can minimise costs and optimise collateral management practices.
Mandated by both the US Dodd-Frank Act and the European Market Infrastructure Regulation (EMIR), the clearing of OTC derivatives through central counterparties (CCPs) was initially scheduled to take effect at the end of 2012. “Implementation, however, has proven to be far more than a mere matter of flipping a switch,” the report notes. Many issues remain unresolved though, including the differences between the US and European rules.
In the US, centralised clearing became mandatory for interest rate swaps last March 2013. Adoption took a three-phased approach for different types and sizes of participants:
- Phase 1: Swap dealers, major swap participants and active funds with 200 or more swaps per month.
- Phase 2: Commodity pools, private funds and other ‘financial entities’.
- Phase 3: All other participants not included>
In Europe, meanwhile, regulators are in the process of registering central clearinghouses and determining which instruments require central rather than bilateral clearing. The process is expected to run into 2014.
Under the new rules, firms trading in OTC derivatives will be required to make larger margin commitments and will be subject to more frequent margin calls. Moreover, different CCPs will have different asset valuation methodologies and margin calculation models, which firms will need a way of tracking. Asset eligibility requirements are expected to vary among CCPs as well, and in most cases are likely to be narrower and more stringent.
All of this would suggest that fund managers need to take a new look at how they manage collateral, the report concludes. However the lag time in implementation means that many are not yet feeling the impact and are taking a wait-and-see approach, comfortable that they have the capacity to cover margins under any circumstances. This is a mistake conclude the authors, who elsewhere in the report promote the cause of proactive collateral management.
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