Portfolio Margining Offers Capital Efficiencies

Terry Flanagan

Clearing organizations are rolling out portfolio margining services that enable clearing firms and their customers to reduce the collateral they are required to maintain against open positions, paving the way for capital efficiencies.

Beginning on May 7, CME Clearing is providing portfolio margining of interest rate futures and cleared OTC interest rate swaps for house accounts, and will begin offering the service for customer accounts later in the year.

Portfolio margining, which is a general term that includes such methods as single- or one-pot margining, enables clearing members to offset positions in multiple asset classes for the purpose of calculating risk.

“Margin and capital requirements being imposed by Dodd-Frank and Basel III are poised to increase significantly the cost of trading on end users and their clearing firms,” Michael Riddle, chief operating officer at Eris Exchange, told Markets Media.

Portfolio margining allows users of Eris Exchange’s benchmark swap futures to experience dramatic capital savings when trading these contracts along with portfolios of CME interest rate futures.

End user margin savings can reach as high as 95% for portfolios of highly correlated positions, Eris Exchange said.

CME Clearing, which has long offered portfolio margining for correlated U.S. dollar-denominated interest rate derivatives, is extending portfolio margining to end users of Eris Exchange futures.

“Eris Exchange is unique in allowing end users to minimize these additional costs through portfolio margining with CME futures, and by posting a wide variety of collateral that includes letters of credit and foreign sovereign debt,” said Riddle.

Eris Exchange futures embed the cash flows of OTC interest rate swaps into a capital-efficient futures form, settle to the CME IRS swap curve and are tradable electronically and through traditional bilateral negotiation.

“This execution flexibility allows existing swaps users to migrate to the centrally cleared world in the manner most comfortable to them, all the while taking advantage of the dramatic capital savings available through portfolio margining with CME futures,” Riddle said.

As a designated contract market (DCM), Eris Exchange is permitted to post customer collateral in 4d segregated accounts maintained by CME Clearing. A 4d segregated account contains funds of customers trading futures and options on U.S. exchanges, and are held separate from the clearing member’s own funds.

Meanwhile, central counterparties are moving to overnight indexed swap (OIS) discounting methodologies in their swap-clearing activities, replacing Libor-based methodologies.

LCH.Clearnet has been using OIS rate curves to discount its interest-rate swaps portfolio in its SwapClear IRS service since 2010, and CME Clearing made the switch to OIS discounting in 2011.

“The use of overnight index swap rate curves for discounting, rather than Libor, is definitely a hot topic,” Ted Leveroni, executive director of derivatives strategy and external relations at post-trade provider Omgeo, told Markets Media.

The International Swaps and Derivatives Association (ISDA) has also indicated support of OIS discounting.

“In fact, one of the stated objectives of ISDA’s standard credit support annex is to support the OIS model,” Leveroni said. “While the use of the standard CSA will remain optional between counterparties, all indications seem to point to OIS as the preferred industry discounting method going forward.”

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