Bilateral Margining and Central Clearing

Current regulation requires that OTC derivative markets implement bilateral margin rules with the requirements applying to virtually all significant OTC derivative users from September 2020. These rules are being phased-in with the aim of reducing systemic risk and promoting central clearing. This, along with related implications, is creating significant changes in the nature of collateralization both in terms of variation margin and initial margin – with the latter, in particular, being very complex to model in terms of costs and risk mitigation benefit.

In this hands-on course we will explore in detail the mechanics of bilateral margin rules for OTC derivatives and assess future scenarios along with their opportunities and risks. The program also covers initial margin methodologies, namely SPAN, Historical VAR, and the ISDA Standard Initial Margin Model (SIMM™). Aspects such as segregation and required CSA changes, multilateral netting, and the growing use of MVA (Margin Value Adjustment) are also explored.

The program is suitable for both banks and end-users of OTC derivatives.

Participants will be able to take away all worked examples, as well as additional exercises and models implemented using Excel functions and macros. They will also receive a copy of Dr Jon Gregory's book "The xVA Challenge: Counterparty Risk, Funding, Collateral, Capital and Initial Margin", published by Wiley Finance.

• Credit traders, Derivatives traders and marketers
• Risk managers and credit risk practitioners
• Structurers
• IT, Middle office
• Senior management, Quantitative researchers
• Product control, Portfolio managers
• Operations / Collateral management

• Numerate background (basic)
• Knowledge of derivatives products
• Basic knowledge of Microsoft Excel

Background

• The OTC derivatives market
• Impact of the financial crisis
• The clearing mandate
• BCBS-IOSCO margin requirements
  • Requirements
  • Phase in
  • Thresholds

Case Study: Impact of bilateral margin requirements for banks under Phase I and II

Counterparty Risk and Risk Mitigation

• Netting
• Portfolio compression
• Margin (collateral)
• Variation margin
• Initial margin (independent amount)

Case Study: Comparison of traditional bilateral clearing, central clearing and clearing under the new margin requirements

The Impact of Collateral

• Discounting and collateral optionality
• Impact of collateral on exposure
• Rehypothecation and segregation
• Collateral and funding
• The impact of initial margin

Case Study: Comparison of collateral usage under traditional bilateral clearing, central clearing and BCBS-IOSCO rules

Mechanics of Bilateral and Central Clearing

• History of central and OTC clearing
• Contractual terms
• Close-out process
• The margin period of risk (MPR)
• CCP loss waterfall and comparison to bilateral markets

Case Study: NASDAQ default fund losses

Traditional Initial Margin Methods

• Standard portfolio analysis of risk (SPAN)
• Value-at-risk (VAR) and expected shortfall (ES)
• Historical simulation
• Example CCP methodologies
• Potential problems
  • Procyclicality
  • Data history
  • Normal vs. absolute returns

Example: Initial margin calculation with historical simulation

The ISDA Standard Initial Margin Model (SIMM™)

• The fundamental review of the trading book (FRTB)
• Variance-covariance approximation to VAR and ES
• SIMM methodology
  • Asset classes and risk classes
  • Risk weights and basis formula
  • Netting
  • Comparison to Historical simulation

​Example: SIMM calculation examples

Initial Margin – Risk Reduction and Cost

• Capital and SA-CCR
• Reduction of counterparty risk (CVA)
• Capital relief from initial margin
• The cost of initial margin
• MVA (margin valuation adjustment)
• The CCP basis

Example: MVA calculation

The Impact of Netting and Margining

• Bilateral vs. multilateral netting
• Does multilateral netting reduce exposure?
• The impact of variation margin
• The impact of initial margin
• Impact on CCP risk management
• Risks of increase in margin requirements

Example: The impact of netting and margining on counterparty risk and CVA