January 18, 2024 (NO COMMENTS)

NEED TO KNOW

Member contributions to default funds have ballooned this year, with some large dealers accusing CCPs of compensating for lower initial margin stemming from new VAR models.

Headline data from clearing houses doesn’t always support individual claims, but within clearing, there are likely winners and losers from the transition to VAR models.

Dealers will foot the bill of increased guaranty fund contributions and stress add-ons while their clients benefit in the move away from Span models.

Regulators are claimed to be agnostic on the trend, but critics say mutualising more of the risk undermines the ‘defaulter pays’ premise of clearing.

What clearing houses giveth with one hand, they taketh away with the other – or so banks are finding. The shift to new margin models for futures and options promises savings for some derivatives users, but dealers are concerned that greater default fund payments could outweigh any such reductions.

These worries may be justified. Contributions by big dealers to the default funds of central counterparties (CCPs) swelled by a cumulative $14 billion in the first half of last year.

Morgan Stanley’s default fund payments rose by 33% half on half. For BNP Paribas, the figure was 29%. Some dealers believe growing demands for default fund contributions are linked to the move by the likes of CME, Ice and JSCC to adopt new models for calculating initial margin based on value-at-risk, in place of the previous iteration of the long-established Span model. VAR models calculate margin requirements at a portfolio level, whereas legacy models assessed margin for individual contracts or asset classes. This means that well-balanced, diversified portfolios are rewarded with lower overall margin requirements as VAR models can identify offsets between different positions.

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