Cost of Trading and Clearing OTC Derivatives in the Wake of Margining

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Over-the-counter (OTC) derivatives markets continue to be impacted by regulatory changes. These changes are affecting the way financial institutions do business in multiple, interrelated ways. Rising capital requirements are impacting profitability and return on equity. Market participants are now being forced to clear standard OTC trades through Central Counterparties (CCPs) and will soon face margin requirements for the remaining, nonstandard, uncleared derivatives (MRUDs). This is prompting firms to better assess and manage costs (funding, collateral, capital) in a consistent fashion at a trade, desk and business unit level. The question is how much of these costs can be passed on to clients.

These changes are not just impacting sell-side firms. Central clearing and MRUDs are also impacting buy-side firms on several dimensions: funding, risk management and naturally valuation and operations. This paper aims to better understand:

  • The various current and future regulatory initiatives – transactional and prudential.
  • The actual Margin Valuation Adjustment (MVA) and its mathematical determination through initial and variation margin adjustments, with numerical examples enriched with capital, liquidity and leverage impacts.
  • The resulting market evolution from the standpoint of pricing and volumes as well as the potential outcomes for market participants.
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