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Central Counterparties : Mandatory Central Clearing and Initial Margin Requirements for OTC Derivatives.

By: Material type: TextTextSeries: The Wiley Finance SeriesPublisher: Newark : John Wiley & Sons, Incorporated, 2014Copyright date: ©2014Edition: 1st edDescription: 1 online resource (329 pages)Content type:
  • text
Media type:
  • computer
Carrier type:
  • online resource
ISBN:
  • 9781118891575
Subject(s): Genre/Form: Additional physical formats: Print version:: Central CounterpartiesLOC classification:
  • HG6024.A3 -- .G74 2014eb
Online resources:
Contents:
Cover -- Title Page -- Copyright Page -- Contents -- Acknowledgements -- PART I: BACKGROUND -- 1 Introduction -- 1.1 The crisis -- 1.2 The move towards central clearing -- 1.3 What is a CCP? -- 1.4 Initial margins -- 1.5 Possible drawbacks -- 1.6 Clearing in context -- 2 Exchanges, OTC Derivatives, DPCs and SPVs -- 2.1 Exchanges -- 2.1.1 What is an exchange? -- 2.1.2 The need for clearing -- 2.1.3 Direct clearing -- 2.1.4 Clearing rings -- 2.1.5 Complete clearing -- 2.2 OTC derivatives -- 2.2.1 OTC vs. exchange-traded -- 2.2.2 Market development -- 2.2.3 OTC derivatives and clearing -- 2.3 Counterparty risk mitigation in OTC markets -- 2.3.1 Systemic risk -- 2.3.2 Special purpose vehicles -- 2.3.3 Derivatives product companies -- 2.3.4 Monolines and CDPCs -- 2.3.5 Lessons for central clearing -- 2.3.6 Clearing in OTC derivatives markets -- 2.4 Summary -- 3 Basic Principles of Central Clearing -- 3.1 What is clearing? -- 3.2 Functions of a CCP -- 3.2.1 Financial markets topology -- 3.2.2 Novation -- 3.2.3 Multilateral offset -- 3.2.4 Margining -- 3.2.5 Auctions -- 3.2.6 Loss mutualisation -- 3.3 Basic questions -- 3.3.1 What can be cleared? -- 3.3.2 Who can clear? -- 3.3.3 How many OTC CCPs will there be? -- 3.3.4 Utilities or profit-making organisations? -- 3.3.5 Can CCPs fail? -- 3.4 The impact of central clearing -- 3.4.1 General points -- 3.4.2 Comparing OTC and centrally cleared markets -- 3.4.3 Advantages of CCPs -- 3.4.4 Disadvantages of CCPs -- 3.4.5 Impact of central clearing -- 4 The Global Financial Crisis and the Clearing of OTC Derivatives -- 4.1 The global financial crisis -- 4.1.1 Build-up -- 4.1.2 Impact of the GFC -- 4.1.3 CCPs in the GFC -- 4.1.4 LCH.Clearnet and SwapClear -- 4.1.5 Lehman and other CCPs -- 4.1.6 Responses -- 4.1.7 Objections -- 4.2 Regulatory changes -- 4.2.1 Basel III -- 4.2.2 Dodd-Frank -- 4.2.3 EMIR.
4.2.4 Differences between the US and Europe -- 4.2.5 Bilateral margin requirements -- 4.2.6 Exemptions -- 4.3 Regulation of CCPS -- 4.3.1 Problems with mandates -- 4.3.2 Oversight -- 4.3.3 CCPs and liquidity support -- PART II: COUNTERPARTY RISK, NETTING AND MARGIN -- 5 Netting -- 5.1 Bilateral netting -- 5.1.1 Origins of netting -- 5.1.2 Payment netting and CLS -- 5.1.3 Close out netting -- 5.1.4 The ISDA Master Agreement -- 5.1.5 The impact of netting -- 5.1.6 Netting impact outside OTC derivatives markets -- 5.2 Multilateral netting -- 5.2.1 The classic bilateral problem -- 5.2.2 Aim of multilateral netting -- 5.2.3 Trade compression -- 5.2.4 Trade compression and standardisation -- 5.2.5 Central clearing -- 5.2.6 Multilateral netting increasing exposure -- 6 Margining -- 6.1 Basics of margin -- 6.1.1 Rationale -- 6.1.2 Title transfer and security interest -- 6.1.3 Simple example -- 6.1.4 The margin period of risk -- 6.1.5 Haircuts -- 6.2 Margin and funding -- 6.2.1 Funding costs -- 6.2.2 Reuse and rehypothecation -- 6.2.3 Segregation -- 6.2.4 Margin transformation -- 6.3 Margin in bilateral OTC derivatives markets -- 6.3.1 The credit support annex (CSA) -- 6.3.2 Types of CSA -- 6.3.3 Thresholds and initial margins -- 6.3.4 Disputes -- 6.3.5 Standard CSA -- 6.3.6 Margin practices in bilateral OTC markets -- 6.4 The risks of margining -- 6.4.1 Margin impact outside OTC derivatives markets -- 6.4.2 Operational risk -- 6.4.3 Liquidity risk -- 6.4.4 Funding liquidity risk -- 6.4.5 Segregation risk -- 6.5 Regulatory margin requirements -- 6.5.1 Background -- 6.5.2 General requirements -- 6.5.3 Threshold -- 6.5.4 Segregation and rehypothecation -- 6.5.5 Initial margin methodologies -- 6.5.6 Non-netting across asset class -- 6.5.7 Haircuts -- 6.5.8 Criticisms -- 7 Counterparty Risk in OTC Derivatives -- 7.1 Introduction -- 7.1.1 Background.
7.1.2 Origins -- 7.1.3 Settlement and pre-settlement risk -- 7.2 Exposure -- 7.2.1 Definition -- 7.2.2 Mark-to-market and replacement cost -- 7.2.3 Non-margined exposure -- 7.2.4 Margined exposure -- 7.3 Valuation adjustments -- 7.3.1 CVA -- 7.3.2 Impact of margin on CVA -- 7.3.3 DVA and FVA -- 7.3.4 Wrong-way risk -- 7.3.5 The balance between counterparty risk and funding -- Appendix 7A: Simple formula for the benefit of a margin agreement -- PART III: STRUCTURE AND MECHANICS OF CLEARING -- 8 The Basics of CCP Operation -- 8.1 CCP setup -- 8.1.1 CCP ownership -- 8.1.2 Fees -- 8.1.3 What needs to be cleared? -- 8.1.4 Important OTC derivative CCPs -- 8.2 CCP operation -- 8.2.1 CCP members and non-members -- 8.2.2 Process of clearing -- 8.2.3 Compression -- 8.2.4 Requirements for products to be cleared -- 8.3 CCP risk management -- 8.3.1 Overview -- 8.3.2 Membership requirements -- 8.3.3 Margining -- 8.3.4 Margin interest rates -- 8.4 Default management -- 8.4.1 Declaring a default -- 8.4.2 Close out process -- 8.4.3 Auction -- 8.4.4 Client positions -- 8.4.5 Loss allocation -- 8.4.6 Wrong-way risk -- 8.5 CCP linkage -- 8.5.1 Interoperability -- 8.5.2 Participant and peer-to-peer models -- 8.5.3 Mutual offset -- 8.5.4 Cross-margining -- 9 Margin and Default Fund Methodologies -- 9.1 Variation margin -- 9.1.1 Valuation -- 9.1.2 Frequency of margin calls -- 9.1.3 Convexity and price alignment interest -- 9.1.4 Variation margin and liquidity risk -- 9.2 Initial margin -- 9.2.1 Close out period -- 9.2.2 Coverage -- 9.2.3 Linkage to credit quality -- 9.2.4 Haircuts and non-cash margins -- 9.2.5 The SPAN methodology -- 9.3 VAR and historical simulation -- 9.3.1 Value-at-risk and expected shortfall -- 9.3.2 Historical simulation -- 9.3.3 Look-back periods -- 9.3.4 Relative and absolute scenarios -- 9.3.5 Procyclicality.
9.4 Initial margins for OTC derivatives -- 9.4.1 Requirements for initial margin approach -- 9.4.2 OTC CCP initial margin approaches -- 9.4.3 Competition -- 9.4.4 Computation considerations -- 9.4.5 Standard initial margin model (SIMM) -- 9.5 Cross-margining -- 9.5.1 Rationale -- 9.5.2 Cross-margining within a CCP -- 9.5.3 Exchange-traded and OTC products -- 9.5.4 Cross-margining between CCPs -- 9.5.5 Methodologies for cross-margining -- 9.6 Default funds -- 9.6.1 Coverage of initial margin -- 9.6.2 Role of the default fund -- 9.6.3 Default fund vs. initial margin -- 9.6.4 Size of the default fund -- 9.6.5 Splitting default funds -- 10 The Loss Waterfall and Loss Allocation Methods -- 10.1 Potential CCP loss events -- 10.1.1 Review of the loss waterfall -- 10.1.2 Clearing member default losses -- 10.1.3 Non-default related losses -- 10.2 Analysis of CCP loss structure -- 10.2.1 Second loss exposure -- 10.2.2 The prisoner's dilemma -- 10.2.3 Unlimited default fund contributions -- 10.2.4 Default fund tranches -- 10.3 Other loss allocation methods -- 10.3.1 Variation margin gains haircutting -- 10.3.2 Partial tear-up and forced allocation -- 10.3.3 Complete tear-up -- 10.3.4 Other methods -- 10.3.5 Impact on client trades -- 10.3.6 Methods used in practice -- 10.4 Capital charges for CCP exposures -- 10.4.1 Qualifying CCPs -- 10.4.2 Trade and default fund related exposures -- 10.4.3 Capital requirements for trade exposures -- 10.4.4 Capital requirements for default fund exposures -- 10.4.5 Method 1 (interim rules) -- 10.4.6 Method 2 (interim rules) -- 10.4.7 Final rules -- 10.4.8 Example and discussion -- 10.4.9 Client clearing and bilateral aspects -- Appendix 10A: Technical details on the interim and final rules -- 11 Client Clearing, Segregation and Portability -- 11.1 Operational aspects -- 11.1.1 General setup.
11.1.2 Principal-to-principal model -- 11.1.3 Agency model -- 11.1.4 Margin requirements between client and CCP -- 11.1.5 Client point of view -- 11.1.6 Clearing member point of view -- 11.1.7 Portability -- 11.2 Segregation, rehypothecation and margin offset -- 11.2.1 The need for segregation -- 11.2.2 The difference between variation and initial margins -- 11.2.3 Net and gross margin -- 11.2.4 Net margin and portability -- 11.3 Methods of segregation -- 11.3.1 Omnibus segregation -- 11.3.2 Individually segregated accounts -- 11.3.3 LSOC -- 11.3.4 Example -- 11.3.5 The liquidity impact of segregation -- 11.4 Regulatory requirements -- 11.4.1 CPSS-IOSCO -- 11.4.2 Dodd-Frank/CFTC -- 11.4.3 EMIR -- 11.4.4 Basel III and capital implications -- PART IV: ANALYSIS OF THE IMPACT AND RISKS OF CENTRAL CLEARING -- 12 Analysis of the Impact of Clearing and Margining -- 12.1 The clearing landscape -- 12.1.1 Bilateral vs. central clearing -- 12.1.2 How much is currently cleared? -- 12.1.3 What should be cleared? -- 12.1.4 The number of CCPs -- 12.1.5 Choosing a CCP -- 12.2 Benefits and drawbacks of OTC clearing -- 12.2.1 Advantages -- 12.2.2 Disadvantages -- 12.2.3 Homogenisation -- 12.2.4 Moral hazard and informational asymmetry -- 12.3 Side effects -- 12.3.1 Futurisation -- 12.3.2 Regulatory arbitrage -- 12.3.3 Netting optimisation -- 12.3.4 Re-leveraging -- 12.3.5 Pricing behaviour -- 12.4 Is there a better idea? -- 13 The Cost and Impact of Clearing and Margining -- 13.1 Overview -- 13.1.1 Strengths and weaknesses of margin -- 13.1.2 Variation margin -- 13.1.3 Initial margin -- 13.2 Examples -- 13.2.1 American International Group (AIG) -- 13.2.2 The BP Deepwater Horizon oil spill -- 13.2.3 Ashanti -- 13.3 The cost of margining -- 13.3.1 Margin and funding -- 13.3.2 How expensive? -- 13.3.3 Variation margin -- 13.3.4 Initial margin.
13.3.5 Converting counterparty risk to liquidity risk.
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Cover -- Title Page -- Copyright Page -- Contents -- Acknowledgements -- PART I: BACKGROUND -- 1 Introduction -- 1.1 The crisis -- 1.2 The move towards central clearing -- 1.3 What is a CCP? -- 1.4 Initial margins -- 1.5 Possible drawbacks -- 1.6 Clearing in context -- 2 Exchanges, OTC Derivatives, DPCs and SPVs -- 2.1 Exchanges -- 2.1.1 What is an exchange? -- 2.1.2 The need for clearing -- 2.1.3 Direct clearing -- 2.1.4 Clearing rings -- 2.1.5 Complete clearing -- 2.2 OTC derivatives -- 2.2.1 OTC vs. exchange-traded -- 2.2.2 Market development -- 2.2.3 OTC derivatives and clearing -- 2.3 Counterparty risk mitigation in OTC markets -- 2.3.1 Systemic risk -- 2.3.2 Special purpose vehicles -- 2.3.3 Derivatives product companies -- 2.3.4 Monolines and CDPCs -- 2.3.5 Lessons for central clearing -- 2.3.6 Clearing in OTC derivatives markets -- 2.4 Summary -- 3 Basic Principles of Central Clearing -- 3.1 What is clearing? -- 3.2 Functions of a CCP -- 3.2.1 Financial markets topology -- 3.2.2 Novation -- 3.2.3 Multilateral offset -- 3.2.4 Margining -- 3.2.5 Auctions -- 3.2.6 Loss mutualisation -- 3.3 Basic questions -- 3.3.1 What can be cleared? -- 3.3.2 Who can clear? -- 3.3.3 How many OTC CCPs will there be? -- 3.3.4 Utilities or profit-making organisations? -- 3.3.5 Can CCPs fail? -- 3.4 The impact of central clearing -- 3.4.1 General points -- 3.4.2 Comparing OTC and centrally cleared markets -- 3.4.3 Advantages of CCPs -- 3.4.4 Disadvantages of CCPs -- 3.4.5 Impact of central clearing -- 4 The Global Financial Crisis and the Clearing of OTC Derivatives -- 4.1 The global financial crisis -- 4.1.1 Build-up -- 4.1.2 Impact of the GFC -- 4.1.3 CCPs in the GFC -- 4.1.4 LCH.Clearnet and SwapClear -- 4.1.5 Lehman and other CCPs -- 4.1.6 Responses -- 4.1.7 Objections -- 4.2 Regulatory changes -- 4.2.1 Basel III -- 4.2.2 Dodd-Frank -- 4.2.3 EMIR.

4.2.4 Differences between the US and Europe -- 4.2.5 Bilateral margin requirements -- 4.2.6 Exemptions -- 4.3 Regulation of CCPS -- 4.3.1 Problems with mandates -- 4.3.2 Oversight -- 4.3.3 CCPs and liquidity support -- PART II: COUNTERPARTY RISK, NETTING AND MARGIN -- 5 Netting -- 5.1 Bilateral netting -- 5.1.1 Origins of netting -- 5.1.2 Payment netting and CLS -- 5.1.3 Close out netting -- 5.1.4 The ISDA Master Agreement -- 5.1.5 The impact of netting -- 5.1.6 Netting impact outside OTC derivatives markets -- 5.2 Multilateral netting -- 5.2.1 The classic bilateral problem -- 5.2.2 Aim of multilateral netting -- 5.2.3 Trade compression -- 5.2.4 Trade compression and standardisation -- 5.2.5 Central clearing -- 5.2.6 Multilateral netting increasing exposure -- 6 Margining -- 6.1 Basics of margin -- 6.1.1 Rationale -- 6.1.2 Title transfer and security interest -- 6.1.3 Simple example -- 6.1.4 The margin period of risk -- 6.1.5 Haircuts -- 6.2 Margin and funding -- 6.2.1 Funding costs -- 6.2.2 Reuse and rehypothecation -- 6.2.3 Segregation -- 6.2.4 Margin transformation -- 6.3 Margin in bilateral OTC derivatives markets -- 6.3.1 The credit support annex (CSA) -- 6.3.2 Types of CSA -- 6.3.3 Thresholds and initial margins -- 6.3.4 Disputes -- 6.3.5 Standard CSA -- 6.3.6 Margin practices in bilateral OTC markets -- 6.4 The risks of margining -- 6.4.1 Margin impact outside OTC derivatives markets -- 6.4.2 Operational risk -- 6.4.3 Liquidity risk -- 6.4.4 Funding liquidity risk -- 6.4.5 Segregation risk -- 6.5 Regulatory margin requirements -- 6.5.1 Background -- 6.5.2 General requirements -- 6.5.3 Threshold -- 6.5.4 Segregation and rehypothecation -- 6.5.5 Initial margin methodologies -- 6.5.6 Non-netting across asset class -- 6.5.7 Haircuts -- 6.5.8 Criticisms -- 7 Counterparty Risk in OTC Derivatives -- 7.1 Introduction -- 7.1.1 Background.

7.1.2 Origins -- 7.1.3 Settlement and pre-settlement risk -- 7.2 Exposure -- 7.2.1 Definition -- 7.2.2 Mark-to-market and replacement cost -- 7.2.3 Non-margined exposure -- 7.2.4 Margined exposure -- 7.3 Valuation adjustments -- 7.3.1 CVA -- 7.3.2 Impact of margin on CVA -- 7.3.3 DVA and FVA -- 7.3.4 Wrong-way risk -- 7.3.5 The balance between counterparty risk and funding -- Appendix 7A: Simple formula for the benefit of a margin agreement -- PART III: STRUCTURE AND MECHANICS OF CLEARING -- 8 The Basics of CCP Operation -- 8.1 CCP setup -- 8.1.1 CCP ownership -- 8.1.2 Fees -- 8.1.3 What needs to be cleared? -- 8.1.4 Important OTC derivative CCPs -- 8.2 CCP operation -- 8.2.1 CCP members and non-members -- 8.2.2 Process of clearing -- 8.2.3 Compression -- 8.2.4 Requirements for products to be cleared -- 8.3 CCP risk management -- 8.3.1 Overview -- 8.3.2 Membership requirements -- 8.3.3 Margining -- 8.3.4 Margin interest rates -- 8.4 Default management -- 8.4.1 Declaring a default -- 8.4.2 Close out process -- 8.4.3 Auction -- 8.4.4 Client positions -- 8.4.5 Loss allocation -- 8.4.6 Wrong-way risk -- 8.5 CCP linkage -- 8.5.1 Interoperability -- 8.5.2 Participant and peer-to-peer models -- 8.5.3 Mutual offset -- 8.5.4 Cross-margining -- 9 Margin and Default Fund Methodologies -- 9.1 Variation margin -- 9.1.1 Valuation -- 9.1.2 Frequency of margin calls -- 9.1.3 Convexity and price alignment interest -- 9.1.4 Variation margin and liquidity risk -- 9.2 Initial margin -- 9.2.1 Close out period -- 9.2.2 Coverage -- 9.2.3 Linkage to credit quality -- 9.2.4 Haircuts and non-cash margins -- 9.2.5 The SPAN methodology -- 9.3 VAR and historical simulation -- 9.3.1 Value-at-risk and expected shortfall -- 9.3.2 Historical simulation -- 9.3.3 Look-back periods -- 9.3.4 Relative and absolute scenarios -- 9.3.5 Procyclicality.

9.4 Initial margins for OTC derivatives -- 9.4.1 Requirements for initial margin approach -- 9.4.2 OTC CCP initial margin approaches -- 9.4.3 Competition -- 9.4.4 Computation considerations -- 9.4.5 Standard initial margin model (SIMM) -- 9.5 Cross-margining -- 9.5.1 Rationale -- 9.5.2 Cross-margining within a CCP -- 9.5.3 Exchange-traded and OTC products -- 9.5.4 Cross-margining between CCPs -- 9.5.5 Methodologies for cross-margining -- 9.6 Default funds -- 9.6.1 Coverage of initial margin -- 9.6.2 Role of the default fund -- 9.6.3 Default fund vs. initial margin -- 9.6.4 Size of the default fund -- 9.6.5 Splitting default funds -- 10 The Loss Waterfall and Loss Allocation Methods -- 10.1 Potential CCP loss events -- 10.1.1 Review of the loss waterfall -- 10.1.2 Clearing member default losses -- 10.1.3 Non-default related losses -- 10.2 Analysis of CCP loss structure -- 10.2.1 Second loss exposure -- 10.2.2 The prisoner's dilemma -- 10.2.3 Unlimited default fund contributions -- 10.2.4 Default fund tranches -- 10.3 Other loss allocation methods -- 10.3.1 Variation margin gains haircutting -- 10.3.2 Partial tear-up and forced allocation -- 10.3.3 Complete tear-up -- 10.3.4 Other methods -- 10.3.5 Impact on client trades -- 10.3.6 Methods used in practice -- 10.4 Capital charges for CCP exposures -- 10.4.1 Qualifying CCPs -- 10.4.2 Trade and default fund related exposures -- 10.4.3 Capital requirements for trade exposures -- 10.4.4 Capital requirements for default fund exposures -- 10.4.5 Method 1 (interim rules) -- 10.4.6 Method 2 (interim rules) -- 10.4.7 Final rules -- 10.4.8 Example and discussion -- 10.4.9 Client clearing and bilateral aspects -- Appendix 10A: Technical details on the interim and final rules -- 11 Client Clearing, Segregation and Portability -- 11.1 Operational aspects -- 11.1.1 General setup.

11.1.2 Principal-to-principal model -- 11.1.3 Agency model -- 11.1.4 Margin requirements between client and CCP -- 11.1.5 Client point of view -- 11.1.6 Clearing member point of view -- 11.1.7 Portability -- 11.2 Segregation, rehypothecation and margin offset -- 11.2.1 The need for segregation -- 11.2.2 The difference between variation and initial margins -- 11.2.3 Net and gross margin -- 11.2.4 Net margin and portability -- 11.3 Methods of segregation -- 11.3.1 Omnibus segregation -- 11.3.2 Individually segregated accounts -- 11.3.3 LSOC -- 11.3.4 Example -- 11.3.5 The liquidity impact of segregation -- 11.4 Regulatory requirements -- 11.4.1 CPSS-IOSCO -- 11.4.2 Dodd-Frank/CFTC -- 11.4.3 EMIR -- 11.4.4 Basel III and capital implications -- PART IV: ANALYSIS OF THE IMPACT AND RISKS OF CENTRAL CLEARING -- 12 Analysis of the Impact of Clearing and Margining -- 12.1 The clearing landscape -- 12.1.1 Bilateral vs. central clearing -- 12.1.2 How much is currently cleared? -- 12.1.3 What should be cleared? -- 12.1.4 The number of CCPs -- 12.1.5 Choosing a CCP -- 12.2 Benefits and drawbacks of OTC clearing -- 12.2.1 Advantages -- 12.2.2 Disadvantages -- 12.2.3 Homogenisation -- 12.2.4 Moral hazard and informational asymmetry -- 12.3 Side effects -- 12.3.1 Futurisation -- 12.3.2 Regulatory arbitrage -- 12.3.3 Netting optimisation -- 12.3.4 Re-leveraging -- 12.3.5 Pricing behaviour -- 12.4 Is there a better idea? -- 13 The Cost and Impact of Clearing and Margining -- 13.1 Overview -- 13.1.1 Strengths and weaknesses of margin -- 13.1.2 Variation margin -- 13.1.3 Initial margin -- 13.2 Examples -- 13.2.1 American International Group (AIG) -- 13.2.2 The BP Deepwater Horizon oil spill -- 13.2.3 Ashanti -- 13.3 The cost of margining -- 13.3.1 Margin and funding -- 13.3.2 How expensive? -- 13.3.3 Variation margin -- 13.3.4 Initial margin.

13.3.5 Converting counterparty risk to liquidity risk.

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