Article: Beat the Experts

13 May 2013 | Bill Hodgson

Between the contributors to this website we ought to be able to answer any question on OTC derivatives and the post-trade space - go ahead and see if you can ask a question we can't answer. Add your question to the comments below or if you wish to remain anonymous email me direct using the Contact page.




Bill, FTT looks likely to apply for transfer title to clearing member - how nuts is that. Re balance sheet treatments - NPV on balance sheet for non-FCM clearing as is cash collateral but not non-cash collateral. Arguable that NPV should be netted with cash collateral. My questions1. When will clients be asked to pay their own Default fund contributions2. When will regulators ban bunched orders for clearing3. When will regulators equalise the margin treatment between futures and OTC so as to remove the artificial labelling treatment and focus on risk/liquidity of underlying products4. When will all CCPs properly use the current client collateral balance and IMR when considering RTR5. When will international regulators harmonise their OTC regulatory environments and properly operate mutual recognition6. When will listed derivative Exchanges be obliged to provide interoperability, share trade feeds and permit other venues to clear/trade their products7. Is there sufficient clearing capacity in the market for all OTC customers to find a clearing broker at reasonable costMore to follow,,,,,,

1. DK 2. Not soon 3. See if Bloomberg cracks that one 4. Soon I believe 5. Not soon 6. Next century? 7. Probably not

Hi Hebe, although this was for "OTC" equities, it is in fact the cash equities market and not OTC derivatives. The reason seems to be a lack of quotes, the full announcement is below, I don't know any more but I assume the market has resumed. It appears to be a need to control the market and avoid chaos without price quotes. I can't see a regulatory gap - it's in intervention as part of the powers of FINRA in the US. Best wishes, Bill.FINRA is invoking its clearly erroneous trade break authority under FINRA Rule 11893 to break all trades in OTC Equity Securities on Thursday, November 7, 2013, after 11:25:00 a.m. ET up and until the resumption of permitted trading at 3:00 p.m. ET for all OTC Equity Securities. FINRA member firms are instructed to cancel all related trades executed during that time period that were reported to FINRAs OTC Reporting Facility (ORF). In making this determination, FINRA has also determined that the number of the affected transactions is such that immediate finality is necessary to maintain a fair and orderly market and to protect investors and the public interest. Consequently, these determinations may not be appealed.Contact Information: Questions regarding this notice can be directed to: FINRA Operations at (866) 776-0800.

Dear OTC community,Regarding the reporting obligation, there are many open questions left. One point I would like you to ask is the following:In table 1 of ESMAs reporting requirements there is field number 22, called Collateralisation, with following fill-in possibilities:U = uncollateralised, PC = partially collateralised, OC = one way collateralised or FC - fully collateralisedWhat does partially collateralised mean?If someone knows the answer or has some inspiration, thanks in advance.

Imagine a CSA with a threshold, the threshold represents the exposure you don't call collateral for, hence this would be one case for PC.

Thank you, Bill!

Bill,I have a question regarding the proposed Financial Transaction Tax (FTT) and the Transfer of Tittle collateral for the IRS offering of EUREX.Do you think that non-cash collateral posted to CCPs as initial margin could find itself hit by the FTT?It could be that the 0.1% tax on bonds as mandated by the FTTcould hit clients that want to clear IRS. The FTT, as it is currently framed, could result in collateral exchanges being hit by the 0.1% transaction tax, and this would of course apply to initial margin posted at CCPs. The FTT would only likely apply to collateral where full ownership transfers to the CCP, as opposed to collateral pledged to the CCP. It is my understanding that CME, EUREX and SwapClear also apply the Transfer of Tittle to collateral.What is your opinion regarding this matter?

Another question:For a SwapClear Clearing Member (SCM), which only acts as a clearing broker for IRS, the SCM appears to have 2 trades at the end, post trade. SCM-CCP and SCM-Client.1. Does the SCM needs to put the IRS position on its balance sheet? There seems to be an exposure on both the CCP and the client of the SCM.2. Does the SCM needs to put the collateral (transfer of Tittle) on its balance sheet? SwapClear:4.1.3 Immediately upon registration by LCH.Clearnet of an Accepted Transaction in Party As Client Account at LCH.Clearnet there shall be constituted an equal and offsetting transaction between Party A and Party B on economic terms identical to those of such Accepted Transaction, except that Party A shall be the party in the position of LCH.Clearnet under such Accepted Transaction and Party B shall be the party in the position of Party A under such Accepted Transaction. Such offsetting transaction shall constitute a Transaction under the Clearing ISDA Master Agreement and the Accepted Transaction shall be the related Associated LCH Transaction.

In both cases I would say yes, subject to the correct calculations of capital.

I can't speak for a specific CCP nor have I studied the FTT in depth, let me investigate the FTT. If the movement of cash or securities to a CCP falls in scope of the FTT then yes, but it will depend on the definition of a transaction.

Barry, I had a quick look at this: http://ec.europa.eu/taxation_customs/resources/documents/taxation/other_...(2011)594_en.pdfBottom of page 7: Central Counterparties (CCPs), Central Securities Depositories (CSDs) and International Central Securities Depositories (ICSDs) are not considered financial institutions in as much as these are exercising functions which are not considered to be trading activity in itself. They are also key for a more efficient and more transparent functioning of financial markets.So by implication, CCPs are excluded from the FTT - Woot.

Thank you!!

Bill,Regarding: So by implication, CCPs are excluded from the FTT. Does this also mean that you would not expect the End client or the Clearing Member to have to pay for the Transfer of Title for the collateral? That is key in the industry. There is a Transfer of Title form the client to the Clearing Member and a Transfer of Tittle to the CCP.

Bill - hope you're still taking questions.Why is SPAN supposed to be better suited to listed futures and options (uniform notional amounts, expirations, strikes etc) and HVaR supposed to be better suited to OTC derivatives (different maturities, coupons, strikes, rates etc) when calculating initial margins for centrally cleared products?Can anyone list the pros and cons for each?!

John, The risk profile of a 3 month interest rate future is substantially different from the profile of a 30 year IRS, hence SPAN has been used as a model to measure the IM requirement on futures, and Historic VaR for portfolios of IRS. It's not really a pros/cons argument, more a case of the right tool for the job. SPAN isn't applicable to IRS, so VaR is necessary, to measure the IM for a portfolio. CME have simple overview of SPAN here: http://www.cmegroup.com/clearing/risk-management/span-overview.html plus Monty Python have a song about it. JPM have an overview of HVaR here: http://www.jpmorgan.com/tss/General/Risk_Management/1159369485859 Amir at ClarusFT can teach you more if you really need to understand VaR. Bill.

My reading of the words is this: If both parties are financial institutions, then FTT applies. A CCP is carved out in the text so Clearing Member CCP is excluded. Therefore Client Clearing Member = two financial institutions, so FTT may apply. Please take independent legal advice on this, the value of investments can go up and down etc. ;-)

Love this post - keep 'em coming :)

Here's one: With ICE launching the CDX.NA.IG futures contract in June 2013 and given a reasonable guess that the futures contract may have a lower margin/overall collateralization than an OTC cleared CDS swap, what percentage of CDS swaps will migrate to the ICE contract?

@ John Philpott - I can also help your with H-VaR vs SPAN related questions. Please LinkedIn me at my page if you want to communicate further on this.-Ben

Ive got an FTT questionSome counterparties (those from the 11 FTT states) bring with them a liability to pay FTT, which then applies to all parties to the trade (who are jointly and severally liable for the full tax payable)So how can you have anonymous trading with these counterparties submitting orders to a CLOB?

If the exchange transmits a trade to clearing very soon after execution, where the CCP steps in - I don't see that politicians can break that model to suit FTT, and therefore only the cleared trade relationships can be taxed. I will be registering a new website soon called www.the-ftt-space.com if this discussion continues ;-)

Rollo, that could prove fun on the new US SEFs if a few Europeans could be sprinkled in the order book, which of course some dealer banks are.

I haven't heard a peep from anyone on their predictions for mandated clearing, but if the first CCP is authorised under EMIR, I believe this triggers the start of the process to determine what the initial products might be. It is rumoured that a Scandi CCP may be approved early. At the moment everyone is focussed on Trade Reporting.Best wishes, Bill

Bill,Has ESMA hinted (or are there rumours in the market) on which derivatives will be initially mandated to clear in Europe. Is it going to be limited like in the US (G4 IRS and index CDS) or more comprehensive (like pretty much everything currently being cleared at LCH and CME). Thanks

Bill,What about the Cftc, what are they waiting to announce new clearing determinations? What do you expect the next products mandated to be? Will there be a phase in again like the previous determination or will all users have to comply at the same time in the next one?Thanks

You beat me, it's not possible to guess what the CFTC will do next, Bill Sent from my iPhone +44 7711 715311 >

Gents, two questions around trade respository reporting under EMIR:Will LCH SwapClear report to trade repositories and if so, will it report not only its own side of the trade but both sides?When and under what circumstances will the ESMA-required field "BeneficiaryID" (table 1, field 11) be filled in and what would one fill in there?Cheers, Tom

Tom, you're supposed to provide answers ;-)I believe (without speaking for SwapClear) that as a CCP it must report the two 'sides' of each trade, being a symmetrical model.Can't answer Q2 - you've beaten us.

Tom,A little bit late,but LCH SwapClear will not offer 'reporting on behalf' to their clients for IRS.The beneficiary field is still under discussion. My personal opinion is that you would need to fill this field if the ultimate economic owner of the position / trade is different than the counterparty to the trade. I do not think that a personal needs to be added in this field, if the person is the economic owner of the trade.Barry

on from the Beat the Experts thread, John Philpott posed some excellent questions on the differences between the Value at

Bill, according to most ccps they are only reporting their own side of the trade, not both. No Emmie obligation to report both and even if there was would it be to the TR chosen by them or the client. If the latter there may be 12 in Europe it could be!

when reporting to SDR is mandatory in USA? is the same mandatory date for all types of assets? and counterparties? the obligations for reporting are the same for "financial counterparties" and "non-financial counterparties"?Thanks

Vicente, your questions are very large and not easily answered quickly, I found a guide which may help here:http://www.chathamfinancial.com/wp-content/uploads/2012/08/Chatham-Finan...

To Tom's question about who is required to trade on a SEF - I believe the ET rules are the same as for clearing so one or both are US persons. This is what has led some SEFs to turn off US person participation leading up to the Oct 2 deadline e.g. ICAP non-USD IRS did this and am sure there are other cases.So far I believe low volume fringe products and those that don't want to trade multi-to-multi have moved either to single dealer platforms (still allowed), voice execution or limited their cpties to non-US persons if they are a non-US person. Also most of the on SEF volume is allegedly in fact voice-electronic hybrid i.e. voice trading with a token amount of electronic-ness. It will be interesting to see how MAT goes (Jan 15th is the estimated date now that Javelin has put the cat among the pigeons for USD/EUR/GBP IRS) i.e. will it push more trading offshore or will people see the benefit? Big players won't get better execution certainty or better pricing and tend to have more flexibility on execution entity. Will they vote with their feet or their IT budget? If big players move offshore, will there be enough liquidity among small players to achieve close bid offer etc.

on from the Beat the Experts thread, John Philpott posed some excellent questions on the differences between the Value at

Article 14 of the EMIR-RTS calls for detailed procedures and processes in relation to dispute resoluation (the identification, recording and monitoring of disputes relating to the recognition or valuation of the contract and to the exchange of collateral). Is that it or are other possible conflicts also meant to beconvered by the process ?

Holger: The article in question is short and only covers the disputes you stated. I assume this article is really related to the operation of margin agreements and the movement of collateral, and not any broader operational activities. As usual - if you need clarity, as a lawyer. ;-)

Thanks you for the reply, Bill. (as I am the lawyer, I would need to ask myself, which does not really help in this case ;-)

http://www.emissions-euets.com/risk-mitigation-techniques-emir/dispute-r...'s also an ISDA PDF if you google "EMIR dispute resolution" which mentions similar confusion on the regulation. I can't see this article covers any other issues.

to Beat the Experts and pose a tough

Bill2 Questions:1. How do ESMA expect us to report multi-leg trades (strategies)? a) repeat the relevant fields in their list of 59+26 fields, within a single report? b) break the trade down into individual vanilla components and report each component separately (with separate UTIs)? c) Just report what we can within the 59+26 fields of a single report? d) none of the above? And how will such a report be matched by our counterparty's report?2 How should we report CFDs under EMIR? In particular when it comes to valuations in July 2014, it makes more sense to report these on the basis of the net position, not on the basis of the individual trades. The individual trades have no maturity date and are not explicitly terminated, so the TRs should consider them to be open indefinitely - in theory requiring valuations every day indefintiely too.

Another question, if I may: are derivative trades between branches of the same company within the scope of Art. 11 EMIR - Timely confirmation ?

If by Branch you mean the same legal entity, then I don't see why they need confirmation in the normal sense, they are like internal trades to transfer risk and not visible outside your organisation. Trades between different legal entities within a corporate group are definitely in-scope for EMIR in various ways. I don't know what EMIR says on branches specifically.

Good question, i don't have more details, i hope they will provide answers to questions like these in the next couple of years.

FX week reports FX swaps and some cross currency swaps will be exempt from initial margin rules. The paragraph relating to cross currency swaps is very vague and it's not clear which types of cross currency swaps will be exempt from initial margining. Is it possible to know which types of CCS will be exempt at this stage? Is it all CCS involving physical exchange? (which would mean 95%+ of the market being exempt in practice)

Hello Bill,May I ask a question concerning the halt for OTC equity securities on November 7? Does it reveal any loophole of regulation? Thanks!

Ask a lawyer?

I'm investigating...

I got a question around SEFs. Who (i.e. which entities) are required to trade via SEFs and if that is any US person as defined by CFTC, can they force a non-US person to trade on a SEF?

Does anyone know the present value of the Default Fund of SwapClear? an dthe total IM? and the C-factor for calculating the capital of DF contributions?Best regards