TABB Group estimates that new margin rules mandated in Dodd-Frank will cause OTC interest-rate derivatives market participants to shoulder at least $1.4 trillion in new capital charges globally within the next 3-5 years.
Although dealers have readily adopted clearing for the most vanilla segment of their OTC derivative portfolios, these exposures require comparatively little initial margin since they represent the cream of the proverbial crop, says E. Paul Rowady, Jr., a TABB senior analyst and author of Initial Margins for OTC Derivatives: The Burden of Opportunity Costs.
Rowady says these margin requirements could cause some types of OTC derivative positions to become extinct due to the cost involved, especially exotic positions and among small portfolios.
Only through cross-margining and other offset mechanisms can these opportunity costs be minimized, he says. Initial margin levels for even the most vanilla trades will continue to be a huge drag on capital, given that theyre starting from zero today. Even small margin requirements attached to huge notional values outstanding have the potential to wreak havoc on product selection.
Rowady says regulators must find better models for clearing and risk management, which would reduce the prohibitive margin requirement costs.
(CG)