Post-Crisis Margin Requirements Start To Bite Large Traders

Post-Crisis Margin Requirements Start To Bite Large Traders
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As Commodity Futures Trading Commission (CFTC) Chair Chris Giancarlo stares down his European counterparts over harmonizing global derivatives regulations, threatening to lock out large EU banks from US derivatives markets, Peter Rippon, CEO of OpenGamma, looks at the confrontation with a knowing smile.

The future is about global regulation, global clearinghouses, and global banks, Rippon told ValueWalk, pointing to the regulatory commonalities rather than the points of contention. “The larger issues are moving in the same direction (regarding margin).”

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Significant regulatory changes that resulted from the 2008 financial crisis are finally starting to materialize and, in some cases, dramatically impacting asset managers utilizing derivatives.

The post-crisis spotlight has been on the largely unregulated SWAPs markets – and this arena is witnessing unprecedented demands forcing tough decisions. But there are also meaningful changes taking place in the listed, cleared derivatives industry and with bi-lateral, non-cleared derivatives transactions as well. London-based Rippon and OpenGamma, in announcing a new US initiative and New York City office launch Wednesday, is at the center.

While Giancarlo continues to play hardball with European regulators to harmonize a more global standard based on the US regulatory approach, Rippon doesn’t think the sides are that far apart.

“The direction of travel is very clear,” he says. “It’s just about who is moving slightly faster to that same destination.”

While regulatory issues of clearing, transparency and net risk exposures contain meaningful nuance are significant differences among regulators, the “direction of travel” regarding margin requirements is clear: Asset managers utilizing derivatives are being required to devote more capital to post as a risk insurance. In some cases the changes are jolting. With SWAPs derivatives, which previously required no clearing or margin requirements in their pre-crisis unregulated structures, now must post margin the same as listed, cleared derivatives.

“As the cost of trading derivatives globally continues to increase, so, too has the adoption of analytics to reduce the cost of capital and protect investor returns,” Rippon said in a statement. “Now, more than ever, understanding and managing margin rather than leaving huge sums of money on the table, is essential for any global macro hedge fund.”

There have historically been meaningful differences between SWAPs and listed derivatives. Listed derivatives contracts are centrally cleared, meaning that the organization that facilitates the trade – the exchange – does not carry the directional risk a SWAPs market maker does, for example. Listed derivatives are required to have transparency into product contents and trade on an open, “lit” exchange where all transaction data is public, meaningful differences with SWAPs, where transaction details are private and product contents have not been transparent, a key issue during the 2008 financial crisis.

Listed derivatives also require traders to post a margin, setting aside capital to ensure that if the trade moves significantly against the trader they have capital on hand to address the issue and are not required to rely on the government for a bailout. For large banks and hedge funds using SWAPs, these new margin requirements are causing consternation. SWAPs transactions that had no clearing or margin requirements now carry meaningful costs.

OpenGamma steps in and helps asset managers streamline and optimize their portfolio to manage margin. Their cloud-based software shows asset managers their total positions across brokerage firms and exchanges. It identifies which positions and traders are gobbling up margin and then makes recommendations to group exposures between brokerage firms and group correlated assets to most efficiently utilize their margin. The firm boasts that one hedge fund achieved a $55 billion in margin savings using the software. In addition to firms such as OpenGamma streamlining margin usage, exchanges are, likewise, developing new listed derivatives products that reduce margin requirements.

It all points to a new world where both the SWAPs and listed derivatives markets are moving to adjust to a more global focus. Eventually, Giancarlo’s stand with EU regulators will be resolved. What will remain standing is a global industry and regulations.

This article first appeared on ValueWalk Premium

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Mark Melin is an alternative investment practitioner whose specialty is recognizing a trading program’s strategy and mapping it to a market environment and performance driver. He provides analysis of managed futures investment performance and commentary regarding related managed futures market environment. A portfolio and industry consultant, he was an adjunct instructor in managed futures at Northwestern University / Chicago and has written or edited three books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008). Mark was director of the managed futures division at Alaron Trading until they were acquired by Peregrine Financial Group in 2009, where he was a registered associated person (National Futures Association NFA ID#: 0348336). Mark has also worked as a Commodity Trading Advisor himself, trading a short volatility options portfolio across the yield curve, and was an independent consultant to various broker dealers and futures exchanges, including OneChicago, the single stock futures exchange, and the Chicago Board of Trade. He is also Editor, Opalesque Futures Intelligence and Editor, Opalesque Futures Strategies. - Contact: Mmelin(at)
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