27 Apr Three Things To Do Before Onboarding Swaps to a CCP
Pre-Onboarding To-Do List
There are many tasks that need to be completed to migrate swap positions to a clearinghouse. This article speaks of three items which should be decided and determine whether to onboard the position into a clearinghouse. At a minimum, these tasks will shed greater light on the cost-benefit of onboarding to a CCP.
1) BOTH UNCLEARED AND CLEARED DERIVATIVES WILL REQUIRE THE POSTING OF INITIAL MARGIN
One of the first important decisions is the clearinghouse you choose and/or the bank you choose to act as your clearing representative, onboarding your trades into the clearinghouse:
Uncleared Derivatives will post the following eligible collateral and haircut:
2) KNOW THE DIFFERENCE IN CHANGING TO STANDARD DOCUMENTATION FOR CLEARED AND UNCLEARED SWAPS
A client who has executed OTC swaps with a bank for many years may find uncleared swap docs changing due to changes in the Standard Initial Margin Method and Standard Collateral Support Annex.
COLLATERAL CONVERSION
Another issue concerning collateral & uncleared swaps is collateral conversion. Collateral conversion (or repo desk) will determine the most cost-effective collateral to post. In other words, a client wants to post the cheapest collateral in their book – the collateral trading at the lowest price relative to its credit rating, liquidity, and corporate reputation.
To offset the equalization of documentation, the lesser quality client will get a lower credit line and a shorter maximum tenor.
3) New SWAPS DOCUMENTATION
The uncleared documentation covering the swap originally will change once transferred to the clearinghouse. Attention should be paid to these legal ramifications.
- Cleared derivatives will be covered by Standard Collateral Support Annex (SCSA) between client and bank.
- Onboarding between clearinghouse and bank will flow through to the clearinghouse-facing agreement between client and bank.
- Special care needs to be taken with regard to how the clearinghouse is handling dilution in the event of bankruptcy or default; this is a post-MF Global, PFG world.
Bilateral swaps positions should be analyzed prior to transfer for cost effectiveness and optimal risk mitigation.
Let’s say you have a swap to pay fixed for 5 years and another swap where you’re receiving fixed for 5 years. These swaps may look like good candidates for onboarding. The SCSAs may start equal, but given a poor collateral conversion (replacement), you may be better off keeping one or both of these swaps in the bilateral OTC world.
We’ll speak more on the topic of converting to Standard Collateral Support Annexes (SCSA) when a document is finalized.