Dodd-Frank in the US and EMIR in Europe requires the mandatory clearing of standardised OTC derivatives. To better align risk management standards and incentivise clearing across all OTC products, regulators have also introduced higher capital charges along with Variation and Initial Margin requirements for non-cleared bi-lateral derivatives. Both regulatory regimes have a phasing-in process that currently has specific counterparty and product exemptions.

BCBS increases in the capital treatment of derivatives and the implementation of other regulatory requirements such as the introduction of a Leverage Ratio and the NSFR have caused a fundamental change in the way derivatives are priced and also how the business is structured and organised.

The demand for High Quality collateral to service both cleared and uncleared bilateral trades along with more stringent HQLA requirements for liquidity buffers is set to rise substantially. This will detrimentally impact institutions that have not integrated collateral management functions for OTC derivatives, have not established collateral optimisation processes, and have not integrated the associated cost of collateral into pricing, risk management and operational frameworks.

Regulatory-imposed scenarios covering stressed outflows and contingent funding events embedded in documentation will also impact derivative portfolios that do not have robust funding and liquidity access in place.

Amongst the questions that need to be resolved:

  • Has an EMIR/Dodd Frank compliant business process been implemented?
  • How to prepare for the increasing complexity and the tools needed to manage it?
  • What decisions need to be made around the Choice of Clearing model?
  • What are the ongoing regulatory and funding implications of being a clearing member?
  • How is the risk exposure to the CCP and the default fund managed?
  • Is the required infrastructure in place to deal with additional VM and IM obligations?
  • Is the most optimal framework in place for funding and liquidity management?
  • What is the capital impact of fragmentation of exposures between CCP’s and other market counterparties?
  • Are processes in place to deal with segregated collateral or restricted rehypothecation?
  • Is the management of frontloading obligations monitored to ensure regulatory compliance?
  • What suboptimal documentation needs remediating?
  • What is the cost allocation model for funding and collateral?
  • Is the approach to recouponing, novation, compression, terminations, compaction and coupon blending maximising the potential RWA reduction benefits?

Solum Financial’s strengths lie in demonstrably independent quantitative skills allied to its experience in financial markets, particularly those in OTC derivatives. Our services for collateral, clearing and funding include:

  • Quantitative impact analysis of CCP and bilateral margin requirements
  • Development of a strategic clearing Target Operating Model
  • Collateral management and optimisation review
  • Funding Risk Management review
  • CSA and collateral documentation remediation advisory
  • Advice on implementation of pricing models to incorporate funding and collateral costs
  • Capital and RWA reduction strategies for seasoned derivative portfolios

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