Posted by Colin Lambert. Last updated: October 17, 2024
A new report from Coalition Greenwich finds that margin optimisation is once again a big feature of market participants’ thinking, including a refocus on how and where they trade interest rates products, as well as where they clear them.
The report, The portfolio Margining Imperative for Interest Rate Deriatives, was authored by Coalition Greenwich senior analyst Stephen Bruel, highlights the cost benefits from margin optimisation, and observes that regulations mandating central clearing of derivatives trades have been effective in reducing systemic risk, but this has come at a cost to market participants in the form of margin requirements.
Margin requirements can be safely reduced when offsetting positions within a firm’s portfolio are held at the same clearinghouse, it says, however, today’s competitive landscape has largely kept US dollar denominated swaps and futures tied to US Treasury and SOFR rates separate.
Higher capital costs have compelled derivatives market participants to be more strategic about how they optimise their margin obligations, driving changes to where they trade and how and where they clear the instruments. Banks interviewed recently by Coalition Greenwich say “capital efficiency through netting and margin optimisation” has become an important factor in how they measure their relationships with central clearinghouses, the firm says.
“Given the prevalence of market participants holding both futures and swaps, a significant opportunity exists to reduce margin requirements and costs by consolidating those positions in a single clearinghouse,” says Bruel. “Not only would individual trading entities benefit, but the financial system would see an improvement in risk efficiency.”
The recently-launched partnership between FMX and LCH is aimed directly at the costs associated with these fragmented margin pools and has reignited the cross-margining discussion amongst market participants as it brings competition with incumbent CME. FMX launched an exchange for US SOFR futures that clear through LCH’s listed Rates clearing service. It plans to launch US Treasury futures in Q1 2025. In this model, there is the potential to offset margin at scale between the futures and interest-rate swaps aiming to compete with the incumbent, Coalition Greenwich observes.
“We project that market participants who clear SOFR swaps and futures bundles in one place could potentially realise significant margin reduction,” says Bruel.
