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Forecasts are for the amount of collateral required
to cover initial and variation margin calls on
derivative positions to expand dramatically in
coming years with some projections showing capital
needs as high as $1.0 trillion. In the U.S., where
implementation of the rules is nearly 1 year complete,
the National Futures Association (NFA) notes
that there has already been a significant surge in
collateral postings.
Markit’s figures earlier showed that government
bonds that are deemed to be high quality liquid assets
(HQLA) make up a significant amount of the lendable
bond supply that is currently unutilized. These are
also, however, the assets most in demand for collateral
being used to meet OTC derivative margin calls.
This is a positive sign for asset owners. Either,
the value of HQLA will increase sufficiently to
re-qualify much of this supply for intrinsic lending
programs or the ability to utilize these assets for
collateral upgrade or downgrade trades will increase.
In either instance, asset owners are going to be
well positioned to benefit from the new OTC
derivatives regulations.
Dodd-Frank & EMIR Rules Dramatically Alter
Derivatives Clearing
Since the crisis, the OTC derivative markets have
undergone a major transformation under the lens of
both the Dodd-Frank Act in the U.S and the European
Market Infrastructure Regulation (EMIR) in Europe.
Dodd-Frank, under Title VII, sought to address the
gap in U.S financial regulation of the OTC derivative
market by providing a comprehensive framework
for the regulation of the global swaps market.
The legislation divided regulatory authority for
oversight of OTC derivative transactions between the
Commodities & Futures Trading Commission (CFTC)
and the Securities & Exchange Commission (SEC).
The SEC has regulatory authority over “security-
based swaps,” which are defined as swaps based on
a single security or loan or a narrowly based security
index. The CFTC has primary regulatory authority
over all other swaps, such as energy and agricultural
swaps, with some shared authority over “mixed
swaps” which are securities-based swaps that have a
commodity component.
Since Dodd-Frank became law in 2010, regulators
have completed significant rule-making to define a
new market structure that includes centralization of
clearing risk with CCPs and increased transparency in
trade execution via Swap Execution Facilities (SEFs).
The implementation of the rules has been staged, but
for designated OTC types, the U.S market has now
fully migrated to a model where risk is centralized
with the CCPs and high quality collateral (cash or U.S
treasuries) is posted to an authorized Futures Clearing
Member (FCM) for onward posting to the CCP.
EMIR officially came into force later than Dodd-Frank—
in August 2012—and many provisions only became
active after technical standards took effect in March
2013, with key aspects of the rules now having been
delayed through 2016. EMIR regulates derivatives,
central counterparties and trade repositories with
a goal of improving transparency and reducing the
risks associated with the derivatives markets. The
regulation sets out a series of guidelines for reporting,
requires central clearing of certain derivatives and
applies risk mitigation standards for uncleared
trades—although these technical standards are yet to
be finalized. The legislation also lays out guidelines
for CCPs and trade repositories.
Generally, EMIR captures financial institutions and
nonfinancial counterparties (NFCs) transacting above
certain clearing thresholds (NFC+). In February 2014,
market participants began reporting information
on derivatives activity to trade repositories. All
counterparties to all derivative contracts, whether
OTC or exchange traded, are required to report post-
trade contract details to a registered trade repository.
While all counterparties are required to report each
trade, they can arrange for one party to report on
behalf of each; this may be a third-party including a
CCP or trading platform.
Section VI: New Derivative Clearing Rules Boost
Demand for HQLA
Changes in the rules governing the treatment of over-the-counter (OTC) derivatives have
transformed the financial landscape post-GFC. New swap exchange facilities (SEFs) are being
mandated for the posting of certain derivative transactions, central clearing of OTC trades has
become an industry norm and bilateral margins are being required on non-cleared swaps.