News review : Greenwich Associates and the virtue of optimisation

GREENWICH ASSOCIATES NEW REPORT EXTOLS THE VIRTUE OF OPTIMISATION.

Banks and their customers could reduce risk, save billions of dollars and improve investment returns by optimising their portfolios in the newly reformed interest rate derivatives market – all while reducing the risk in the system, according a new report from Greenwich Associates – Derivatives Clearing: The Next Chapter from Greenwich Associates.

The report concludes that the global derivatives market has successfully navigated the transition to the new clearing framework established by regulators in the wake of the global financial crisis, and is thriving today “because of, not in spite of, a slew of post-crisis legislation and regulation put in place over the past decade.”

It notes that reducing the amount of capital required to back derivatives trading is the key to higher profitability for banks and lower costs for investors. While on the surface this sounds like a systemically risky proposition, banks and their derivative customers should better optimise their swaps and futures holdings across clearinghouses. This would not only sharpen their risk management processes but also in a default scenario, the overall risk in the system would justify reducing the amount of capital required.

“Optimising a single dealer’s $10tn notional cleared derivatives portfolio could generate a reduction in capital requirements of $11.4bn dollars,” says Kevin McPartland, Head of Market Structure and Technology Research at Greenwich Associates, and author of the new report. “Apply that estimate across the top 10 derivatives dealers in the world, and the benefits become impressively clear.”

McPartland also believes that changing the rules set into motion by Basel III to exclude client margin from leverage ratio calculations could also be quite positive, reducing the amount of capital the largest clearing banks need to hold by roughly $20bn. “That money can then be used to bring on new clients, reduce clearing fees for existing customers or both,” he adds. “The change would also have a beneficial impact on swap dealers’ ability to provide liquidity to customers, making it more economical to hold positions and freeing up capital to facilitate additional client trades.”

Moreover, the report points out that regulatory action, while not required, could also boost savings and reduce risk in the interest rate derivatives market. Every $100m reduction in initial margin would result in a $30m reduction in bank capital requirements and a $400,000 reduction in fees to investors.

“Although regulators are increasingly likely to push through positive changes to capital rules, market participants are not and should not count on them to move their businesses forward,” concludes Kevin McPartland. “Dealers must continue to optimise their portfolios to gain access to the billions of dollars in capital savings available under the new market structure.”

©BestExecution 2017

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