A proposal to divvy up margin payments of individual swaps users at clearinghouses rather than allowing accounts to be treated as one pool by banks representing multiple customers may make guaranteeing trades too expensive, a U.S. commodity regulator said today.
Some swaps users favor the proposal because it would prevent one customer’s margin from being used to offset a deficit owed by another, Commodity Futures Trading Commissioner Scott O’Malia wrote in a letter to the U.S. Chamber of Commerce. It would also make operating the system more expensive for everyone, he said.
“While this proposal has certain merit, it has been suggested that it could lead to a substantial increase in the cost of clearing by placing the individual interests of a single client above those of the system and introduce a certain moral hazard into the clearing system,” O’Malia said in the letter.
The CFTC is working on rules to implement the Dodd-Frank Act passed by Congress in July. The law mandates that most swaps be guaranteed by clearinghouses to lessen systemic risk.
The idea O’Malia wrote to the Chamber and other swaps users about today would allow swaps clearinghouses to know which margin payments belong to individual bank customers like hedge funds or corporations. Existing futures markets allow banks to pool all their customer accounts together when settling a day’s margins. O’Malia is seeking feedback on how to handle swaps margins.
Corporations that are using swaps to hedge commercial risk will be exempt from having to use clearinghouses, though many may want to do so if the cost isn’t prohibitive, O’Malia said in a telephone interview yesterday.
“We’re going from a system where we’re trying to fix ‘too-big-to-fail’ to one where it’s too expensive to clear,” he said. “I have a real concern about that.”
Clearinghouses, which are capitalized by their members, are meant to reduce systemic risk by absorbing and sharing responsibility if a member defaults on its payment obligations. They use daily margin calls to keep accounts current and provide regulators with access to prices and positions.
Clearinghouse owner CME Group Inc. (CME) said last month that it may raise margin 50 percent to 100 percent to offset the increased cost of creating individual accounts for thousands of swaps users, O’Malia said. Intercontinental Exchange Inc. (ICE) said payments at its clearinghouses may rise 63 percent, he said.
Morgan Stanley’s O’Connor
Typically in the U.S. futures market, the clearinghouse holds margin it requires on a bank-by-bank basis as opposed to splitting out the margin belonging to the bank customers, said Stephen O’Connor, head of Morgan Stanley (MS)’s counterparty portfolio management group.
In contrast, the system used at LCH.Clearnet Ltd., the world’s largest interest-rate swap clearinghouse, allows the clearinghouse to individually segregate margin by customer, he said.
That system “is more expensive to run,” O’Connor said.
O’Malia said in the letter that market users have raised concerns that individual segregation of margin could increase the risk at a clearinghouse by shifting the burden of oversight from the banks that are clearinghouse members to the clearinghouse itself. It could also lead the bank members to reduce the amount of capital they hold to the minimum required, he said.
O’Connor said the decision on individual customer segregation may ultimately be left to the swap users.
“I think the rules will be changed to allow that at the client’s option,” he said.