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

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Chapter 13

The Cost and Impact of Clearing and Margining

Any change, even a change for the better, is always accompanied by drawbacks and discomforts.

Arnold Bennett (1867–1931)

13.1 OVERVIEW

Mandatory clearing and bilateral margining requirements will have one stark impact on the OTC derivatives market: a significant increase in margin requirements. Whilst it is not surprising that post-GFC regulation was focused around the reduction of counterparty risk, a concern is that the related funding and liquidity impacts of such regulation are in danger of being overlooked. This chapter considers the cost implications of the clearing and margining mandates and their potential liquidity effects. Assessing this is difficult because it will be driven by subtle aspects such as the quality of margin required, segregation and the functioning of repo markets. Nevertheless, it is important to characterise the impact of the increase in margin as a balance between reducing counterparty risk but increasing funding liquidity risk.

13.1.1 Strengths and weaknesses of margin

During the global financial crisis (GFC), the reliance of financial institutions on short-term debt made them particularly vulnerable to the outbreak of problems in longer-dated markets (such as subprime mortgages). Excessive reliance on short-term funding markets has been cited by many as an important contributor to the severity of the GFC.

In one sense it is not a surprise that mandatory clearing and initial margin requirements ...

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