BIS: Clearing CDS through a CCP could cost “G14 dealers” $100B in margin requirements
The Bank for International Settlements published a nice working paper this morning ("Collateral requirements for mandatory central clearing of over-the-counter derivatives") that lays out a framework for calculating the costs to the towering derivatives complex of moving forward with regulatory reform to make mandatory clearing of credit default swaps and interest rate swaps through central counterparties.
Statistical types may enjoy examining the methodology used in the paper to "fill in the blanks" given the sparse data available on the makeup of swaps actual portfolios, but suffice it to say that the main finding is that certain banks in a group known as the "G14 dealers" -- the most active in the OTC derivatives space -- could find themselves on the wrong end of major margin calls under a CCP arrangement in the inevitable event of periods of high market volatility.
Here are the data that were estimated using the framework advanced in the paper. Note, for example, that the grey cells in the interest rate swaps (IRS) table on the left are essentially total notional amounts in IRS books divided 50-50 between long and short positions, as this breakdown is not publicly available:
Then, the paper takes these hypothetical portfolios designed to represent the G14 dealers' books based on available information and measures their reaction to different levels of volatility in CDS and IRS observed over the past several years. The chart on the left is the four-year euro fixed-for-floating and the one on the right is JPMorgan 5-yr senior CDS. They both show daily changes in market values measured as percentages of notional principal amounts:
Applying three different levels of historical volatility as observed above to the G14 dealers' constructed portfolios, "dealer 6" (i.e. DB per the list above) could be looking at $8 billion in potential variation margins in the event another Lehman-style situation, while "dealer 9" (i.e. JPMorgan) could also face staggering margin calls of over $5 billion:
The interest rate swaps add a nice chunk of change to margin requirements in periods of high volatility as well:
Finally, the total initial margins required by all of the G14 dealers in the event of a period of high market volatility could be over $100 billion for CDS portfolios alone...
...and around another $42 billion on IRS books:
One can see how things could get expensive.