PRAGUE Buysiders and sellsiders are fretting over a Commodity Futures Trading Commission idea floated Monday which has been interpreted as requiring both initial margin and variation margin to be held by third party custodians. The idea was released in a factsheet, which sets out margin rules for uncleared trades, refers to collateral having to be held by a third party custodian. Officials take that to mean both initial and variation margin.
James Hill, a managing director at Morgan Stanley, although noting that the final rule has yet to be published, warned having collateral for interdealer trades held by third party custodians would have serious trade costs for clients as well as liquidity implications. I say that because, as a dealer, we are effectively acting as an intermediary--clients ask us to take risk, we take risk, then over a period of time we distribute it in the most efficient way so we can offer our clients the best price and take the large amounts of risk on behalf of our clients, he said on the OTC Clearing panel at the International Swaps and Derivatives Association annual general meeting here yesterday.
Hill used the example where a client would want to sell USD100 million in protection on a credit, meaning that the dealer would buy protection and then hedge some of its exposure in the interdealer market. The margin the dealer would collect from the hedges in the interdealer market would be paid back to its clients on the trade, since the dealer would effectively be acting as an intermediary. If I have to take the margin from my interdealer trades and put it with a third party custodian, what it means is the margin that I have to post on my client trades I effectively have to raise capital to have that margin, said Hill. So on a USD100 million trade with a USD20 million margin call, in todays world you simply pass the margin through. In this new world which covers variation margin, I have to raise USD20 million in capital.
Officials noted that, if the new rule did include variation margin, the industry would be facing the prospect of a cost surpassing USD1 trillion. The proposal is expected to be published for comment in the next few days by the CFTC. One official on the sidelines of the conference noted the topic of variation margin was also starting to be discussed in further detail amongst European Commission and European Parliament members.