Cleared world of OTC derivatives to produce spike in margin calls.
As OTC derivatives transition from a bilateral to a centrally cleared environment, the derivatives industry is being faced with a landslide of margin calls that will need to be processed with greater speed and efficiency than the present manual process.
That’s resulted in a platform for automating the margin call process for derivatives.
AcadiaSoft allows market participants to communicate vital information on exposures, commitments and adjustments between counterparties in a complete, verifiable and secure manner.
The platform, launched in 2011, has succeeded in attracting sell side and buy side customers, all major players in the OTC space.
“In 2011, we got a lot of the big sell side firms integrated onto the platform,” Craig Welch, co-founder and CEO of AcadiaSoft, told Markets Media. “We also worked to get a handful of hedge fund administrators onto the platform, because administrators have relationships with multiple buy side firms.”
AcadaiSoft has created MarginSphere, a margin confirmation community that provides a central and transparent infrastructure where counterparties engaged in collateral management can electronically confirm, manage and track margin calls.
Recent buy side additions include Bluebay Asset Management, Cheyne Capital Management and Goldman Sachs Asset Management (GSAM).
“We spent the better part of a year getting key buy side and sell side players to agree on a mutually agreeable workflow,” said Welch.
Counterparty credit risk has emerged as one of the most pressing issues among market participants, regulators, agencies and lawmakers. As a result, firms have embraced collateral management as the standard for risk mitigation and are therefore demanding increased efficiency and transparency in this area.
“While the business case for Acadia was strong in the pre-cleared world, with clearing, the economics are tilted highly in our favor,” Welch said.
In the bilateral world, there’s an average of a single margin call per week made by a swap dealer to counterparty. However, in the centrally cleared world, that number is going to skyrocket.
“When the business shifts to central clearing, the CCP issues a single margin call to the FCM, and the FCM will then break that single call into multiple calls to end customers,” Welch said. “So in the cleared world, there’s a margin call every single day, and sometimes multiple times a day.”
This will be the case regardless of which model is adopted for segregation of collateral on cleared swaps, such as Complete Legal Segregation Model (CLSM), under which both the FCM and the derivatives clearing organization are required to segregate the cleared swaps collateral relating to each customer.
“There’s all kinds of models but at the end of the day the number of margin calls is going to spike,” Welch said. Unlike in the bilateral world, where margin calls are negotiable, margin calls in the cleared world will be generated automatically, and will require an automatic response.
“With bilateral calls, the thresholds that will trigger a margin call might be a half million dollars or more, but in the cleared world, if the positions are a dollar out of balance, that will trigger a margin call,” Welch said. “The rules are set by the CCP in conjunction with regulators.”
Phase 5 of the uncleared margin rules (UMR) took effect from September 2021.
Temporary equivalence is set to expire on June 30 2022.
IRS trading volumes have fragmented without an equivalence agreement.
Phase 5 of the uncleared margin rules came into effect on 1 September.
Triparty repos can be executed across U.S. Treasury securities to central clearing.