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Irresistible appeal of CCP portfolio margining

On 25 February 2016, the CFTC requested public comments on the petition of LCH.Clearnet Limited (“LCH”) to introduce portfolio margining across certain exchange-traded interest rate futures and OTC interest rate swaps.

Economically-correlated interest rate futures would be pooled with OTC rate swaps for margining purposes, resulting in reduced collateral requirements for clearing members, and ultimately, the clients. This would result in a strong argument to clear all eligible products at LCH.

A client would be required to clear the positions through one clearing member rather than through multiple clearing members in order to maximise the benefits of portfolio margining.  In other words, the margin for a listed derivative cleared with clearing member A could not be offset against the margin for an OTC rate swap cleared with clearing member B.

Starting in the first half of 2016, LCH proposes to gradually implement portfolio margining to the classes below:

Rates Swaps Rates Futures
Basis Swaps Short-Term Interest Rate (STIR) Future
Forward Rate Agreement (FRA) Swap Futures / Deliverable Swap Future (DSF)
Inflation Swap Long Term Interest Rate (LTIR) Future
Interest Rates Swap (IRS)
Overnight Index Swap (OIS)
Variable Notional Swap (VNS)
Cross-Currency Swap

 

Request for relief

 

LCH is seeking relief from certain regulatory restrictions in order to implement portfolio margining. The customer protection provisions of the Commodity Exchange Act (“CEA”) and CFTC Regulations applicable to future commission merchants (“FCMs”) ordinarily prevent commingling of positions, customer funds, property and other margin related to futures. Equivalent restrictions apply to OTC swaps.

A similar request for relief was submitted to the CFTC by CME in May 2012, and subsequently approved. CME indicated then that portfolio margining could result in margin savings of up to 85%.

Overview

 

Participation will be optional. Portfolio margining could be activated in respect of the clearing member’s house positions, or in respect of client positions on a legal entity-by-legal entity basis[1].

Portfolio margining will require the combination of the existing Listed Interest Rate Default Fund and SwapClear Default Fund for OTC rate derivatives, along with their default management rules and loss allocation waterfalls.

Consolidation

 

LCH’s initiative has been a long time coming and represents a logical step forward in the convergence of the futures and the OTC derivatives worlds.

It will no doubt lead to the consolidation of the clearing networks, with a concentration around the few CCPs able to offer collateral offsetting across asset classes. At the same time, concentration is also likely to occur at the clearing member level as optimal portfolio margining can only be achieved if a client uses one single clearing member for all its positions.

Comments must be submitted to the CFTC by 11 March 2016.

[1] “The FCM Portfolio Margining Service would not be available, for example, where a non-clearing FCM opens an omnibus customer account with an FCM Clearing Member on behalf of such non-clearing FCM’s customers; such account is treated by the FCM Clearing Member as a single customer. However, the account contains multiple legal entities that are not disclosed to LCH, and therefore LCH is not able to identify margin efficiencies on a per-customer basis.”

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