Includes bibliographical references (pages 293-297) and index.
Contents:
Machine generated contents note: pt. 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. Contents note continued: 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. Contents note continued: 4.3. Regulation of CCPS -- 4.3.1. Problems with mandates -- 4.3.2. Oversight -- 4.3.3. CCPs and liquidity support -- pt. 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. Contents note continued: 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. Contents note continued: 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 -- pt. 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. Contents note continued: 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. Contents note continued: 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. Contents note continued: 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. Contents note continued: 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 -- pt. 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. Contents note continued: 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 -- 13.3.6. Manifestation of funding liquidity risks -- 13.4. Implications -- 14. Risks Caused by CCPs -- 14.1. Overview -- 14.1.1. General risks created by CCPs -- 14.1.2. Risks for clearing members -- 14.1.3. Risks for non-clearing members. Contents note continued: 14.2. Historical CCP failures and near misses -- 14.2.1. New York Gold Exchange Bank (1869) -- 14.2.2. Caisse de Liquidation (1974) -- 14.2.3.COMEX (1980) -- 14.2.4.Commodity Clearing House (1983) -- 14.2.5. Hong Kong Futures Exchange and 1987 crash -- 14.2.6. BM & FBOVESPA (1999) -- 14.2.7. Lessons from past CCP failures -- 14.3. Important considerations -- 14.3.1. Hindsight bias -- 14.3.2. Race to the bottom? -- 14.3.3. Distributive effects and the big picture -- 14.3.4. Mutualisation and CCPs as CDOs -- 14.3.5. The need for margin -- 14.3.6. The impact of mandatory clearing -- 14.3.7. Transparency -- 14.3.8. Interconnectedness -- 14.4. Risks faced by CCPS -- 14.4.1. Default risk -- 14.4.2. Non-default loss events -- 14.4.3. Model risk -- 14.4.4. Liquidity risk -- 14.4.5. Operational and legal risk -- 14.4.6. Other risks -- 14.5. Keeping CCPs safe -- 14.5.1. Will they be allowed to fail? -- 14.5.2. Governance -- 14.5.3. Disclosure -- 14.5.4. Insurance schemes. Contents note continued: 15. The Future Impact on Financial Markets -- 15.1. Regulatory change -- 15.2. The impact -- 15.3. Good or bad?
Summary:
The Global Financial Crisis, from 2007 onwards, illustrated the inherent weaknesses in the global financial system and some of their causes. In particular over-the-counter (OTC) derivatives were blamed by many for partially causing and catalysing the crisis. Not surprisingly, this has led to dramatic action from politicians, policymakers and regulators in relation to OTC derivative markets. Two of the most important changes are the mandatory clearing of standardised OTC derivatives and the requirements for bilateral margin posting in non-standard OTC contracts. Both clearing and margining mandates will be effectively phased in from 2014 and the associated costs will be severe. These regulatory changes are therefore going to create a dramatic shift in the topology of financial markets, together with a significant reallocation of counterparty and systemic risks. Knowledge of the subject is an important consideration for all financial institutions whether they are CCP members, Clear trades indirectly or find themselves subject to bilateral margin requirements. Central Counterparties: Mandatory Clearing and Bilateral Margin Requirements for OTC Derivatives explains the central clearing of OTC derivatives and the associated bilateral margin requirements. The book provides a historical perspective of central clearing as it developed with derivative exchanges in order to mitigate counterparty credit risk. The regulatory requirements (Dodd-Frank, EMIR, Basel III) being imposed since the global financial crisis are defined and discussed. The mechanics of central clearing are described including operational aspects, initial margin and default fund calculations, loss waterfalls and allocation methods. Client clearing is discussed, in particular giving detail on margin segregation and portability methods. An assessment is made throughout of the advantages and disadvantages of clearing and margining requirements, including potential issues such as funding liquidity risk, operational risk and wrong-way risk. The book is unique and covers the regulatory requirements together with the practical implementation details and the potential impacts and consequences. It is an invaluable and complete reference guide for any market practitioner, policy maker, academic or student with responsibility or interest in the area of OTC derivatives. --Book Jacket.
This resource is supported by the Institute of Museum and Library Services under the provisions of the Library Services and Technology Act as administered by State Library of Iowa.