Buy Side Backs Bloomberg Margin Request

By Will Rhode, TABB GROUP

Originally published on TABB Forum 

IFMA has come out in support of Bloomberg’s request to the CFTC to reduce the 5-day VaR calculation if initial margin for swaps to the same 1-day VaR requirement for futures. But shouldn’t it be left to each DCO to determine margin requirements based on how it chooses to compete in the marketplace? 

The Asset Management Group (AMG) of the Securities Industry and Financial Markets Association (SIFMA) has written to the CFTC in support of Bloomberg’s letter requesting relief from the 5-day VaR calculation of initial margin for swaps vs. the 1-day VaR requirement on futures. In its letter it states:

AMG believes that the minimum liquidation time of 5 days for Non-commodity Swaps (a) is arbitrary and overly conservative, (b) is based on a fundamentally flawed assumption as to differences in liquidity between futures and swaps, (c) creates an artificial economic incentive for market participants to use futures rather than swaps and (d) is contrary to Congress’s goal of promoting trading of swaps on swap execution facilities (SEFs). We strongly believe that the minimum liquidation time for Non-commodity Swaps should be the same as for Futures and Commodity Swaps – i.e., 1 day – with DCOs using their reasonable and prudent judgment to set higher liquidation times for particular types or classes of transactions where warranted by their specific liquidity characteristics as evidenced by quantitative analyses derived from sources such as swap data repository data. 

While we at TABB Group sympathize with the buy side’s struggle to deal with new clearing costs associated with swaps trading, and while we appreciate the illogic of an un-level playing field in margin treatment for what may be two economically equivalent products, we question the degree of intervention that the CFTC should take in determining DCO margin requirements. Should it be the CFTC that determines these things, or the DCOs themselves?

The AMG letter continues:                    

Rule 39.13(g) provides that DCOs shall employ models that will generate margin requirements adequate to cover the DCOs’ potential future exposure to a clearing customer’s position based on price movements between the last collection of variation margin and the time within which the DCO estimates that it would be able to liquidate a defaulting clearing member’s positions. Under the final rule, the models must assume, unless an exception is granted, that it will take at least one day to liquidate futures and options (“Futures”) and agricultural commodity, energy commodity and metal swaps (“Commodity Swaps”) and that it will take at least five days to liquidate all other swaps (“Non-commodity Swaps”).  In the preamble to the final rules, the Commission explained that these “bright-line” minimum liquidation times would provide certainty to the market, ensure that margin requirements would be established for the “thousands of swaps that are going to be cleared” and prevent a potential “race to the bottom” by competing DCOs. 

The question becomes: How literally should the industry interpret the “bright line” drawn by the CFTC? This appears to be more an attempt at guidance, rather than an outright prescription. More to the point, Dodd-Frank has mandated for competition in clearing, so shouldn’t it be left to each DCO to determine the margin requirement based on how it chooses to compete in the marketplace? Some DCOs will opt to become more conservative in their margin calculation as they seek to demonstrate their risk management expertise and stability. Others will emphasize their ability to offer savings through margin efficiencies and cross-product netting. The point is, it should be up to the DCO to determine how it wants to define its value proposition, not the CFTC.

To that end, we believe that the AMG misses the point when it says: “Surely, it could not have been Congress’ intent in adopting Title VII of the Dodd-Frank Act for the Commission to create a market structure that would move liquidity away from swaps and into futures.” 

The intention of Congress and Dodd-Frank is quite clear: reduce systemic risk. This is true of the transparent trading mandate, central clearing and trade reporting. So it seems unnecessarily risky at this point to demand that the CFTC reduce swap margins just as clearinghouses are being intermediated into the derivatives market to improve financial market safety.

The AMG is right to point out that the appropriate liquidation time for derivatives will be affected by a number of factors, including the trading volume, open interest, and predictable relationships with highly liquid products. But we believe that should be left to the DCOs, which are the experts in such matters, to determine.