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 interrelated changes are affecting financial institutions and their business operations. For example, rising capital requirements are impacting profitability and return on equity market participants are now being forced to clear standard OTC derivatives trades through Central Counterparties (CCPs). Soon, there will even be 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 manner 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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