A skeptical look at derivative margin requirements
Now that the clock is ticking on the new Dodd-Frank rules that will effectively create a new OTC derivatives market--I've likened this to a Big Bang--the issue of margin has reared up all over again.
DealBook has weighed in with a skeptical look at some of the dire projections we've heard about the margins that participants will be forced to post. The ISDA aims of course to highlight the burdens that the new rules impose. It has argued that initial margin rules would likely to lead to a "significant liquidity drain" on the market, estimated to be in the region of $15.7 trillion to $29.9 trillion."
But DealBook says the lower bound assumes that many banks "calculate their derivatives exposures in an advantageous manner sanctioned by the proposed regulations. Specifically, the rules allow banks to offset certain trades with each other. This has the effect of reducing a bank's overall derivatives exposure for the purposes of calculating margin. The upshot: less margin is needed. At one stage in its analysis, the derivatives association says using this approach might reduce by half the overall amount of derivatives in the calculation. But why wouldn't the reduction be far more than $14 trillion, or roughly 50 percent? After all, net exposure can be reduced quite sharply by using the offsetting method. For instance, a bank may have $50 billion on trades betting that stocks go up and $49 billion on trades betting stocks go down, leading to a $1 billion net exposure for the bank."
The essay suggests that the 50 percent figure is arbitrary. My sense is that we will really not know exactly what the margin burdens will be until trading begins in earnest. But the danger is that some legitimate hedgers will be forced out of the market. The speculators will be just fine.
- here's the article