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Central Counterparties: Mandatory Central Clearing and Initial Margin Requirements for OTC Derivatives

Book Description

The Global Financial Crisis, from 2007 onwards, illustrated the inherent weaknesses in the global financial system and some of their causes. In particular over-the-counter (OTC) derivatives were blamed by many for partially causing and catalysing the crisis. Not surprisingly, this has led to dramatic action from politicians, policymakers and regulators in relation to OTC derivative markets. Two of the most important changes are the mandatory clearing of standardised OTC derivatives and the requirements for bilateral margin posting in non-standard OTC contracts. Both clearing and margining mandates will be effectively phased in from 2014 and the associated costs will be severe. These regulatory changes are therefore going to create a dramatic shift in the topology of financial markets, together with a significant reallocation of counterparty and systemic risks. Knowledge of the subject is an important consideration for all financial institutions whether they are CCP members, clear trades indirectly or find themselves subject to bilateral margin requirements.

Central Counterparties: Mandatory Clearing and Bilateral Margin Requirements for OTC Derivatives explains the central clearing of OTC derivatives and the associated bilateral margin requirements. The book provides a historical perspective of central clearing as it developed with derivative exchanges in order to mitigate counterparty credit risk. The regulatory requirements (Dodd-Frank, EMIR, Basel III) being imposed since the global financial crisis are defined and discussed. The mechanics of central clearing are described including operational aspects, initial margin and default fund calculations, loss waterfalls and allocation methods. Client clearing is discussed, in particular giving detail on margin segregation and portability methods. An assessment is made throughout of the advantages and disadvantages of clearing and margining requirements, including potential issues such as funding liquidity risk, operational risk and wrong-way risk.

The book is unique and covers the regulatory requirements together with the practical implementation details and the potential impacts and consequences. It is an invaluable and complete reference guide for any market practitioner, policy maker, academic or student with responsibility or interest in the area of OTC derivatives.

Table of Contents

  1. Cover
  2. Half Title page
  3. Title page
  4. Copyright page
  5. Dedication
  6. Acknowledgements
  7. Part I: Background
    1. Chapter 1: Introduction
      1. 1.1 The Crisis
      2. 1.2 The Move Towards Central Clearing
      3. 1.3 What is a CCP?
      4. 1.4 Initial Margins
      5. 1.5 Possible Drawbacks
      6. 1.6 Clearing in Context
    2. Chapter 2: Exchanges, OTC Derivatives, DPCs and SPVs
      1. 2.1 Exchanges
      2. 2.2 OTC Derivatives
      3. 2.3 Counterparty Risk Mitigation in OTC Markets
      4. 2.4 Summary
    3. Chapter 3: Basic Principles of Central Clearing
      1. 3.1 What is Clearing?
      2. 3.2 Functions of a CCP
      3. 3.3 Basic Questions
      4. 3.4 The Impact of Central Clearing
    4. Chapter 4: The Global Financial Crisis and the Clearing of OTC Derivatives
      1. 4.1 The Global Financial Crisis
      2. 4.2 Regulatory Changes
      3. 4.3 Regulation of CCPS
  8. Part II: Counterparty Risk, Netting and Margin
    1. Chapter 5: Netting
      1. 5.1 Bilateral Netting
      2. 5.2 Multilateral Netting
    2. Chapter 6: Margining
      1. 6.1 Basics of Margin
      2. 6.2 Margin and Funding
      3. 6.3 Margin in Bilateral OTC Derivatives Markets
      4. 6.4 The Risks of Margining
      5. 6.5 Regulatory Margin Requirements
    3. Chapter 7: Counterparty Risk in OTC Derivatives
      1. 7.1 Introduction
      2. 7.2 Exposure
      3. 7.3 Valuation Adjustments
      4. Appendix 7A: Simple Formula for The Benefit of a Margin Agreement
  9. Part III: Structure and Mechanics of Clearing
    1. Chapter 8: The Basics of CCP Operation
      1. 8.1 CCP Setup
      2. 8.2 CCP Operation
      3. 8.3 CCP Risk Management
      4. 8.4 Default Management
      5. 8.5 CCP Linkage
    2. Chapter 9: Margin and Default Fund Methodologies
      1. 9.1 Variation Margin
      2. 9.2 Initial Margin
      3. 9.3 VAR and Historical Simulation
      4. 9.4 Initial Margins for OTC Derivatives
      5. 9.5 Cross-Margining
      6. 9.6 Default Funds
    3. Chapter 10: The Loss Waterfall and Loss Allocation Methods
      1. 10.1 Potential CCP Loss Events
      2. 10.2 Analysis of CCP Loss Structure
      3. 10.3 Other Loss Allocation Methods
      4. 10.4 Capital Charges for CCP Exposures
      5. Appendix 10A: Technical Details on the Interim and Final Rules
    4. Chapter 11: Client Clearing, Segregation and Portability
      1. 11.1 Operational Aspects
      2. 11.2 Segregation, Rehypothecation and Margin Offset
      3. 11.3 Methods of Segregation
      4. 11.4 Regulatory Requirements
  10. Part IV: Analysis of the Impact and Risks of Central Clearing
    1. Chapter 12: Analysis of the Impact of Clearing and Margining
      1. 12.1 The Clearing Landscape
      2. 12.2 Benefits and Drawbacks of OTC Clearing
      3. 12.3 Side Effects
      4. 12.4 Is There a Better Idea?
    2. Chapter 13: The Cost and Impact of Clearing and Margining
      1. 13.1 Overview
      2. 13.2 Examples
      3. 13.3 The Cost of Margining
      4. 13.4 Implications
    3. Chapter 14: Risks Caused by CCPs
      1. 14.1 Overview
      2. 14.2 Historical CCP Failures and Near Misses
      3. 14.3 Important Considerations
      4. 14.4 Risks Faced by CCPS
      5. 14.5 Keeping CCPS Safe
    4. Chapter 15: The Future Impact on Financial Markets
      1. 15.1 Regulatory Change
      2. 15.2 The Impact
      3. 15.3 Good or Bad?
  11. Glossary
  12. References
  13. Index