Distribution Advisory, LPA Solutions
Case Study – Clearing & Collateral Management
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According to the »European Market Infrastructure Regulation« (EMIR), new rules apply to the collateralisation of uncleared OTC-derivatives since the 1st of March. Thus new derivatives transactions have to be collateralised with a variation margin, and depending on the transaction volume with an initial margin on top.
These collateral-requirements are regulated by framework agreements or new collateralisation annexes (Credit Support Annexes). Because of that, they pose an administrative challenge for existing derivatives(-portfolios): Institutes can conduct their old and new business per counterparty under various contracts, or they agree to adjust derivatives contracts to the new regulations.
The re-structuring can have a significant influence on the recoverability of the entire portfolio. Because of that, it is important that both counterparties have the same level of information. Our client was addressed by his counterparties concerning a re-arrangement of his collateralisation annexes. The aim of the project was to qualify the recoverability of the re-arrangement of the collateralisation annex with the respective counterparty.
The Strategy / Our Approach
First, the portfolio was transferred to LPA and validated according to a comparison of market values. After that, assumptions were agreed upon which serve as a proxy for the counterparty risk / rating and funding costs for the institute itself as well as for the counterparty. Certain value-determining factors (e.g. break-clauses) were discussed and agreed. Several calculations were done using various assumptions to determine a spread as basis for negotiations—from the perspective of the institute as well as the counterparty. The calculations were adjusted according to the progress of the discussion.
Because of various xVA-effects (Credit Valuation Adjustment, Funding Valuation Adjustment) the benefits of one counterparty can exceed the disadvantage of the other counterparty—in total, this results in a net margin that can be allocated between both parties. In this context, our evaluation software LPACalc offers the possibility to assess existing portfolios under different CSA-drafts from the perspective of both counterparties. The tool enables the projection of the complete recoverability of the re-structuring.
Under different assumptions we determined the impact of potential re-arrangements of selected CSA-contracts of the client and supported bilateral negotiations with the counterparty. In this way, significant payoffs for the re-arrangements could be achieved.