Hedgeweek looks at developments in store for the rates clearing space in the coming six months ahead of the anticipated go-live date for the Dodd-Frank clearing mandate in the US. In the US specifically, the Commodity Futures Trading Commission (CFTC) has already passed several major elements of its final Dodd-Frank Act rules on clearing, including core principles for derivatives clearing organisations that set the minimum capital requirement for institutions seeking to become direct clearing members of a central counterparty (CCP) at just $50 million.
Hedge funds are generally much more nimble than other buy-side participants. Their typically smaller corporate structure allows them to move faster than more traditional investment managers, and they have a much greater degree of autonomy in making strategic decisions.
A key feature of some CCPs is a requirement that variation margin can only be posted in cash and in the same currency that the underlying interest rate swap is denominated in: only euros can be posted as collateral against a euro interest rate swap, for example.
Typically, the credit support annexes (CSAs) that govern margin procedures between hedge funds and their dealer counterparties do not include the same restriction, allowing managers to post US dollar, sterling or yen against a euro swap. The cross-currency basis risk inherent in posting collateral in a currency different to the denomination of the trade should be reflected in the trade valuation and may result in a different price for the swap relative from that where collateral is posted in the swap denomination currency. This adds further time and complexity to swap valuation and makes a less transparent valuation process.
CCPs are in the process of expanding the eligible collateral that they will accept from clearing members, away from traditional margin instruments like cash and government bonds, to include a broader array of assets. Clearing houses are also exploring options further to alleviate pressure on collateral assets by investigating the feasibility of extending cross-margining services across different asset types to include interest rate swap portfolios for the first time.
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