Risk Focus technology partner OpenGamma has released an insight paper addressing some of the key benefits of standardized Initial Margin (IM) calculations for financial institutions interacting with central counterparties (CCPs).
According to Mas Nakachi, CEO of OpenGamma, calculating standardized metrics in such as Initial Margin (IM) offers a significant cost saving opportunity for the fixed income and commodities (FICC) business. With global revenues in the FICC space down by 20-40% in the last few years, combined with regulatory capital pressures in OTC derivatives, cost-cutting opportunities are particularly important. Recent advances in standardized technology such as the OpenGamma computation engine can now calculate Initial Margin with the same or greater speed and accuracy as internally-developed systems at far lower cost.
In the area of CCP Initial Margin, the common argument that more accurate pricing provides an edge in the markets does not hold. Whereas more efficient pricing may be valid in structured products trading, there is no valid reason to calculate Initial Margin differently than the CCP. Since the goal is simply to replicate the CCPs IM calculation, financial institutions trading OTC derivatives have the opportunity to replace expensive proprietary pricing tools with standardized tools to achieve significant cost benefits. Reducing technology costs is one means of offsetting diminished FICC profitability.
In addition, banks often overfund their collateral books to offset end-of-day differences in the CCP’s Initial Margin calculation and that of the bank’s internal pricing systems. Over-collaterization can cost a financial institution significant basis points, placing a continuous drag on the FICC unit’s profitability and unnecessarily consuming risk-weighted capital. Replicating the CCPs IM calculation eliminates the need to over-collaterize OTC derivatives books to cover end-of-day IM calculation surprises, potentially providing a large cost savings in reduced collateral.
To read further about improving FICC margins with standardized CCP Initial Margin calculations, you can find it here on OpenGamma’s site.