The end of the PSA clearing exemption – the Clearing Advantage
Since our blog of the 25th March the European Commission has announced that the Pension Scheme Arrangements (PSAs) temporary exemption from clearing will end in June 2023. The original exemption was introduced ten years ago in 2012. After multiple extensions, the countdown has finally begun.
If you are a Pension scheme which is unsure about clearing your OTC rates and credit derivatives, here is a review of the key considerations^:
Greater Protection from Counterparty Default
Reduced counterparty risk is easily the top incentive for clients when considering clearing.
The Clearing houses offer greater protection of your positions and collateral during a default event than in a bilateral market comparable to an insurance policy, with the initial margin and default/guarantee fund contribution being the insurance premium. These financial assets, previously contributed by the defaulted party, will be used first to cover the losses incurred in closing out its defaulted positions.
The clearing house’s financial assets, or its skin in the game, are also available to cover excess default losses beyond the defaulted party’s assets.
Global Liquidity Pools & Standardised Product Sets
Access to liquidity is another primary reason for clearing – clearing houses attract and consolidate liquidity. This is evident in voluntary clearing activities beyond the mandated products in some OTC markets, and the bid/offer spreads are generally tighter in clearing.
Optimisation between cleared and uncleared OTC positions may move firms under the AANA (Aggregate Average Notional Amount) threshold for Uncleared Margin Rules (UMR), thus potentially eliminating the requirement to post 2-way initial margin (IM) for bilateral derivatives
A 2018 quantitative assessment^ suggested lower all-in costs with clearing (including fees and IM margin add-ons) covering major asset classes (including rates, credit and oil). More significant savings from clearing could be achieved for certain client trading profiles and products.
Margin and settlement optimisation with post-trade netting and compression is common practice in clearing. Uncleared positions could also be included with third-party solutions.
Innovative pre-trade analytics also exists for firms to help identify the lowest margin across competitive CCPs (CCP switch) prior to trade execution.
Greater access to clearing for PSAs
One of the top challenges for asset-rich PSAs to centrally clear their OTC derivatives has been the requirement to post cash intraday to cover variation margin (VM). Intraday calls can be made multiple times a day and have a short settlement window which needs to be met or could potentially result in a default event.
With the end of PSA clearing exemption in sight, top clearing houses are offering post-trade solutions to further open clearing and address the liquidity challenge.
For example, PSAs can raise cash to fund the intraday margin calls in their OTC clearing by clearing repos at the clearing house under an agency or sponsored model.
Are you feeling lost in the clearing universe?
At Margin Reform, we have a team of expert practitioners well-versed in margin reduction, capital conservation, and collateral optimisation across both cleared and bilateral markets.
With our experience of onboarding firms onto top clearing houses and our partnerships with post-trade solution providers, we have the know-how to accelerate your ability to clear from strategy to execution.
Get in touch today to find out more.
^ Source: the FSB DAT assessment published in November 2018.