Lehman 15 years on: margin guidelines have diminished threat, however elevated complexity

By Joe Midmore, Chief Business Officer, OpenGamma

With right this moment marking the 15-year anniversary of the collapse of Lehman Brothers, the ripple results that it had by world monetary markets are nonetheless being felt in many alternative methods. Lehman Brothers’ collapse was, in fact, partially triggered by its publicity to extremely complicated derivatives. The widespread use of over-the-counter (OTC) derivatives like credit score default swaps (CDS) and the opacity of those markets contributed to the disaster.

Within the aftermath of the collapse and the broader monetary disaster, regulators world wide have sought to handle the dangers related to derivatives buying and selling. One of many key responses over the previous one and a half many years has been the implementation of clearing and margining necessities for OTC derivatives.

Take the enforcement of the worldwide uncleared margin guidelines (UMR) as a primary working example. UMR has been phased over the previous six years to reinforce transparency, threat administration, and stability within the monetary system by addressing a number of the points uncovered by the monetary disaster, together with the usage of derivatives.

The aim of the regulation was to introduce standardised margin for      uncleared (OTC) trades which finally ends up making it costlier to commerce bilaterally (pushed by greater margin necessities) which, finally, makes clearing extra enticing and, in some situations, ends in contributors having to de-lever. UMR does this by requiring corporations to put up upfront collateral as safety when doing trades, tying up trillions of {dollars} of property that might in any other case generate returns.

It encourages a shift away from the bilateral OTC world, into clearing by CCPs, which goal to scale back counterparty threat by offering a central entity that ensures trades. This transfer has broadly talking helped to scale back threat among the many funding banking group nevertheless it has additionally meant that a whole lot of asset managers and pension funds (with portfolios above €8bn in notional) which have beforehand by no means needed to put up preliminary margin, have been compelled to take action. This has introduced a significant operational and liquidity problem for any firm doing giant volumes of non-cleared OTC trades.

For the reason that UMR guidelines began to be phased again in 2016, 1000’s of corporations have been made to hold out large quantities of labor on the identical time. Along with the operational impression of this process, these adjustments have considerably elevated the price of buying and selling. The meant impact of those adjustments is that corporations might be strongly incentivised to cease two events buying and selling a contract between one another (bilaterally uncleared), and transfer in the direction of central clearing for any commerce that may be cleared. Whereas clearing additionally entails posting margin, that is usually near half the extent of bilateral buying and selling (5bp).

There may be additionally an enormous query mark over whether or not banks that present clearing providers have capability on their stability sheets to deal with a barrage of corporations      now seeking to clear. Though many corporations have clearing agreements in place, clearing brokers are unable to supply long-term clearing certainty and subsequently  retain the correct to drag entry to their providers with as little as one- or two-months’ discover.

World monetary markets are, in fact, structurally very totally different to how they had been 15 years in the past. With regulatory adjustments, similar to UMR, which have occurred over that point to monetary market stability, corporations have needed to adapt. They have to depend on doing issues the way in which that they did in what’s now primarily a very totally different period. When all is alleged and accomplished, the necessity for non-bank establishments like pension funds and asset managers to work out easy methods to effectively put up and optimise their margin obligations is important, particularly when one contemplates the huge adjustments to market construction for the reason that collapse of Lehman.