Lehman 15 years on: margin guidelines have decreased danger, however elevated complexity

Lehman 15 years on: margin rules have reduced risk, but increased complexityBy Joe Midmore, Chief Industrial Officer, OpenGamma

With immediately marking the 15-year anniversary of the collapse of Lehman Brothers, the ripple results that it had by means of international monetary markets are nonetheless being felt in many various methods. Lehman Brothers’ collapse was, in fact, partly triggered by its publicity to extremely complicated derivatives. The widespread use of over-the-counter (OTC) derivatives like credit score default swaps (CDS) and the opacity of those markets contributed to the disaster.

Within the aftermath of the collapse and the broader monetary disaster, regulators world wide have sought to handle the dangers related to derivatives buying and selling. One of many key responses over the previous one and a half a long time has been the implementation of clearing and margining necessities for OTC derivatives.

Take the enforcement of the worldwide uncleared margin guidelines (UMR) as a major living proof. UMR has been phased over the previous six years to boost transparency, danger administration, and stability within the monetary system by addressing a few of the points uncovered by the monetary disaster, together with the usage of derivatives.

The aim of the regulation was to introduce standardised margin for      uncleared (OTC) trades which finally ends up making it dearer to commerce bilaterally (pushed by greater margin necessities) which, in the end, makes clearing extra enticing and, in some cases, ends in contributors having to de-lever. UMR does this by requiring corporations to publish upfront collateral as safety when doing trades, tying up trillions of {dollars} of belongings that would in any other case generate returns.

It encourages a shift away from the bilateral OTC world, into clearing by means of CCPs, which goal to scale back counterparty danger by offering a central entity that ensures trades. This transfer has broadly talking helped to scale back danger among the many funding banking neighborhood but it surely has additionally meant that tons of of asset managers and pension funds (with portfolios above €8bn in notional) which have beforehand by no means needed to publish preliminary margin, have been pressured to take action. This has introduced a serious operational and liquidity problem for any firm doing giant volumes of non-cleared OTC trades.

Because the UMR guidelines began to be phased again in 2016, hundreds of corporations have been made to hold out big quantities of labor on the similar time. Along with the operational impression of this process, these adjustments have considerably elevated the price of buying and selling. The supposed impact of those adjustments is that corporations can be strongly incentivised to cease two events buying and selling a contract between one another (bilaterally uncleared), and transfer in the direction of central clearing for any commerce that may be cleared. Whereas clearing additionally includes posting margin, that is sometimes near half the extent of bilateral buying and selling (5bp).

There’s additionally an enormous query mark over whether or not banks that present clearing providers have capability on their stability sheets to deal with a barrage of corporations      now seeking to clear. Though many corporations have clearing agreements in place, clearing brokers are unable to supply long-term clearing certainty and due to this fact  retain the fitting to tug entry to their providers with as little as one- or two-months’ discover.

World monetary markets are, in fact, structurally very completely different to how they had been 15 years in the past. With regulatory adjustments, resembling UMR, which have occurred over that point to monetary market stability, corporations have needed to adapt. They need to depend on doing issues the best way that they did in what’s now primarily a very completely different period. When all is claimed and executed, the necessity for non-bank establishments like pension funds and asset managers to work out the way to effectively publish and optimise their margin obligations is important, particularly when one contemplates the huge adjustments to market construction for the reason that collapse of Lehman.