Buy side firms required to submit swaps to their elected clearinghouses by one or more of four dates: March 11, April 11, May 11 or June 11, 2013. The fifth and final date is February 18 2014.
Offsetting Bilateral Swap Positions
The decision to submit a swap to a CCP has much to do with the collateral (and haircut) the buy side firm will have to post to the CCP relative to the type of collateral and haircut required by the bilateral counterparty,
This same decision re cross currency swaps is less trivial, specifically due to the CCP’s process used to find a single margin currency. In the bilateral world, your OTC swap may be documented to use the traded (accrual) currency. At. MHDS we followed a three step process to organize our client’s positions and then defined which positions should remain OTC.
Compression is the first step to offsetting bilateral swap positions and can close many open positions right off the bat. Compression allows the user to easily bucket currency and maturity risk. TriOptima’s TriReduce product has been the compression product of choice. you can learn more about compression by reading “Three Vital Steps To Maximise Capital Savings“and “optimizing leverage ratios and reducing risk”. The CME also provided a useful compression resourcem which can be found here.
Maturity, Payment Date Differences
The second step was to determine the difference between the remaining tenors. A monthly fixed swap vs an annual swap would be held to the side to see if the different tenors gave the client and collateral posting advantage.
Swaps with Embedded Options
The third step was to re-price all swaps with embedded calls and/or puts and locate the underlying asset on which they were transacted.
The non-bullet swaps resulted primarily in two buckets:
1) Cases where the relationship between these non-bullet swaps and bonds had narrowed to a point where keeping the trades on the books was no longer relatively profitable (relative to cost of funding); and
2) Cases where the relationship between swaps and bonds were too wide to take off. In the latter case, keeping the swap bilateral was the only choice as Clearinghouses are not yet taking callable swaps.
Noting the CDS (or calculating the implied CDS. Knowing whether the CDS is trading at a higher premium than the swap vs. bond (positive basis) or the CDS is trading at a lower premium (negative basis) is added to the final report.
Once these initial steps are taken it will be clear whether offsetting bilateral swap positions is possible. The next step is for the risk Manager to review a prepared report detailing their risks as well as their greatest cost of collateral. Then the decision to carry the risk bilaterally can be made with full confidence the previously described steps have been take care of.
Further Reading: Here’s s a link to Emily Perryman’s excellent piece for www.hedgeweek.com, which you can read here.