Interview: Cross margining, an optional service for real benefits

Alexander Rose, Vice President at Eurex Clearing and Nick Chaudhry, Head of OTC Client Clearing, Commerzbank met to exchange thoughts on how the ETD and OTC derivatives markets are shifting and to discuss two of the current industry buzzwords: cross margining and capital efficiencies.

Alexander Rose: Cross margining has been the buzzword in the financial industry lately, sparking vivid discussions among buy and sell side. What is your view on cross margining?

Nicholas Chaudhry: The calculations necessary for margin optimization are complex but conceptually the framework is straightforward. Cross margining takes into account offsetting risks between two different instruments, resulting in risk reduced margin calls. The ability to provide and support cross product margining is a key differentiator for CCPs, more than the proposition of widening out the eligible collateral pool. This is testified by the push from CCPs and in particular Eurex Clearing to include fully automated cross product margining solutions in their business models.

Alexander Rose: Cross margining is the possibility to offset listed and OTC fixed income exposure: how important do you think is this for your clients? And on the flip-side, what is the resulting impact for you as the Clearing Member?

Nicholas Chaudhry: Cross margining solutions allow clients the potential to secure capital efficiencies, by reducing the amount of collateral the client would have to post to the CCP. The entire market, buy and sell side institutions, are focused on the increased costs of trading OTC derivatives. Hence, solutions that reduce this burden are likely to be a powerful driver of clearing flows and liquidity going forward as the OTC clearing market matures.

Alexander Rose: Which clients do you believe would benefit the most from offsetting the OTC and the ETD business?

Nicholas Chaudhry: Without naturally offsetting positions, there is no benefit to be had from cross product margining and clients will have to face the demand for substantial increases in collateral. That said, any category of client could benefit if its portfolios contain risk offsets. Moreover, putting in place an account that supports cross product margin does not increase costs even if no offsets are present, and would improve operational process as both ETD and OTC would be treated the same as cleared derivatives. With that in mind all clients should review cross margining options with their Clearing Broker.

Alexander Rose: What can clients expect by working together with Commerzbank towards OTC clearing and cross margining?

Nicholas Chaudhry: Being the first European Clearing Broker to support cross product margining at Eurex, Commerzbank is very well positioned to provide this service and advise clients.

Alexander Rose: Eurex Clearing has been the first CCP to establish a fully automatic cross margin solution on the fixed income side. What are the biggest hurdles to get fully up and running from a process point of view?

Nicholas Chaudhry: We have designed the process so that clients don’t need to do much to change to portfolio margining. From an operational perspective we insulate clients from most of the non-core business operations tasks. We work closely with our clients to determine the overall margin reduction that could be appreciated by running portfolio simulations, whilst providing advice on account set up and bespoke reporting. Along with the fully automated margin solution, customers are truly being offered an optional key solution.

Alexander Rose: In the current OTC client-onboarding process, what challenges are the most imminent and toughest to meet for the sell side and the buy side? How do you help tackle them?

Nicholas Chaudhry: The challenges include: legal documentation, technical set-up and end user training. At Commerzbank we have an expert team of onboarding managers with a long history of onboarding clients to assist our clients every step of the way. We put the client at the heart of our service provision, providing a full project management approach with dedicated onboarding managers who guide the client through the full lifecycle from mandate to go live.

Alexander Rose: As the ETD processes are usually well implemented it's the OTC clearing part which is fairly new to most market participants. What do you see as the biggest tasks for your customers when it comes to OTC clearing and the integration of the ETD business into the equation for cross margining?

Nicholas Chaudhry: Historically ETD and OTC derivatives businesses have been siloed, often housed with different clearing brokers and each with its own liquidity pool. Integrating these services will often require new legal documentation, change to order processing/management and reporting.

Alexander Rose: Do you believe that most market participants already fully understand all the impacts of the OTC regulation and how to comply with it? What do you recommend participants to ensure their readiness for mandatory clearing?

Nicholas Chaudhry: On the whole I believe the market has had long enough to familiarize itself with the high level concept of clearing. However, not all participants understand the complex considerations that must be reviewed and determined in order to meet regulatory obligations. This process, without the right expertise, can be daunting and time consuming. Notwithstanding the phase in periods ESMA has afforded Cat 2, 3 and 4 clients. As the clock is ticking my advice is to act now by engaging with their service providers sooner rather than later to ensure there is enough time to have clearing provisions in place before the onset on mandatory clearing starts in Europe.

Nicholas Chaudhry, Head of OTC Client Clearing, Commerzbank In his 17 years of capital market experience he has held senior positions in fixed income prime brokerage and OTC client clearing businesses in Europe and Asia. At Commerzbank Nicholas is responsible for developing OTC Client Clearing solutions and strengthening the product offering to clients. OTC Client Clearing at Commerzbank is focused on delivering tailored solutions to clients looking to address the regulatory requirements that have arisen from EMIR and broader regulatory change. OTC Client Clearing is a core component of the new Market Services' product solution service, which the Bank offers to its clients.

Alexander Rose, VP Business Development Collateral & Risk, Eurex Clearing Based in Eurex Clearing’s headquarters in Frankfurt, he is an experienced clearing expert, focusing on financial risk management, margin methodologies, margin replication, cross margining, default management procedures, collateral optimization and capital efficiencies. At Eurex Clearing, Alex is a client-facing Business Development manager and supports buy and sell side clients in these topics.

What is Cross Margining?

While our VaR based margin method offers portfolio offsets within an asset class, Eurex Clearing Members who are clearing both ETD and OTC positions can further benefit from an optional service called cross margining.

A given account is checked every two hours by a proprietary algorithm to determine whether there are futures or options available which share the same or similar risk characteristics along the interest rate curve, and would therefore act as a hedging position to an OTC exposure.

A so-called ‘Optimizer’ detects these opportunities and immediately brings down the margin requirements to create cross margining efficiencies. Cost savings are highly depending on the given portfolio structure and diversity across ETD and OTC positions, but can provide substantial savings. The cross margining service is part of our Eurex Clearing Prisma offering and is optional service that is fully automated – at no additional costs.