Swaps investors should be prepared to pay more for clearing services if they want their margin protected against being used to fund another investor’s default, industry executives said during a panel discussion in Florida.
The Commodity Futures Trading Commission has proposed divvying up margin payments of individual swaps users at clearinghouses rather than allowing accounts to be treated as one pool by banks representing multiple customers. Existing futures markets allow banks to pool all their customer accounts together when settling a day’s margins.
“What’s the cost? The assumption is there will be no material cost to this, and I don’t think that’s a safe assumption,” Christopher Edmonds, president of ICE Trust, the world’s largest credit-default swap clearinghouse, said today at the annual Futures Industry Association meeting in Boca Raton, Florida.
A shift to segregating cash on a customer-by-customer basis will either lead to higher margin payments or more money required by the clearinghouse in what’s known as the guarantee fund, said Kim Taylor, president of CME Group Inc. (CME)’s clearinghouse. A guarantee fund is comprised of lump sum deposits investors must make that are proportional to their net position. It’s used to cover a default if the margin isn’t enough.
Some swaps users such as BlackRock Inc., the world’s largest asset manager, favor the proposal because it would prevent one customer’s margin from being used to offset a deficit owed by another.
Goldman Sachs View
“If we pull them out of that, isn’t it going to increase margin dramatically?” said Michael Dawley, co-head of futures and derivatives clearing services at Goldman Sachs Group Inc. and chairman of the Futures Industry Association.
“Clients continue to be frustrated about this issue,” said Dawley, who moderated a panel of clearing executives. “It would be good to figure this out as an industry to put this to bed.”
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.
Additional customer margin protection won’t add costs to clearing, said Roger Liddell, chief executive officer of LCH.Clearnet Group Ltd., owner of the world’s largest interest-rate swap clearinghouse.
“The cost of it is zero,” he said.
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.
CME Group said in October that it may raise margin 50 percent to 100 percent to offset the increased cost of creating individual accounts for thousands of swaps users, according to CFTC Commissioner Scott O’Malia, who raised cost concerns about the proposal at the time. Intercontinental Exchange Inc. (ICE) told the CFTC payments at its clearinghouses may rise 63 percent, O’Malia said.
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