27 Apr Three Things To Do Before Onboarding Swaps to a CCP
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:
- Standard initial Margin Method
- Standard Collateral Support Annex
Another issue concerning collateral & uncleared swaps:
- 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:
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
3a) Uncleared swap positions should be analyzed for offset versus remaining uncleared
EXAMPLE: Let’s say you have two swaps: SWAP A to pay fixed for 5 years and SWAP B receiving fixed for 5 years. These swaps may look like good natural offset.
But if COUNTERPARTY A wants to onboard to a clearinghouse and COUNTERPARTY B (perhaps a corporation) who needs the swap to remain an Uncleared Derivatives.
- The SCSA’s may start equal, but given a poor collateral conversion (replacement), you may be better off
- We’ll speak more on the topic of converting to Standard Collateral Support Annexes (SCSA) when the rules are finalized.