Dealers worry about risk of $500bn overnight liquidity drain

Dealers are concerned that a principle they claim could drain $500 billion from the financial system overnight will remain in the final set of guidelines for central counterparties (CCPs) and other market infrastructures.

The Committee on Payment and Settlement Systems (CPSS) and technical committee of the International Organization of Securities Commissions (Iosco) published a consultation paper on principles for financial market infrastructures in March 2011, and a final version is expected to follow in the next two months, the CPSS says.

However, dealers are worried about a principle on CCP intra-day margin calls that appeared in the consultation paper. If it is included in the final version, it could suck up to $500 billion in liquidity from dealers on an overnight basis during a crisis, they claim.

“If you’re a bank in a very strong liquidity position, then maybe this issue doesn’t matter so much, but some other clearing members might suffer problems because of this. It’s another effect of these new regulations that could make the system less safe,” says Ulrich Karl, director of regulatory change at HSBC in London.

The concerns were spelled out in a letter from the International Swaps and Derivatives Association dated February 2. The CPSS confirmed it had received several responses from the industry, but declined to comment on whether the matter would be addressed in the final rules.

“The CPSS has received several letters, which it is taking seriously. However, it would not be fair to provide feedback on specific comments until the final version of [the CPSS/Iosco principles] comes out,” it says in a statement.

The problem centres on a proposal that CCPs should have the authority and operational capacity to make intra-day calls for margin, both on an ad hoc basis and when clearing member positions have lost significant value. That might sound reasonable if markets move dramatically and exposures change during the day – but dealers point out this requirement only works one way, and most CCPs do not provide a physical payment for accounts with net mark-to-market gains. One notable exception is Chicago-based CME Group, which currently pays out 80% of gains to members on intra-day margin calls, the February 2 letter notes.

The impact of this one-way flow of collateral is likely to be exacerbated by the emergence of multiple CCPs, participants say. Essentially, the ability to choose between several clearing houses means netting sets are likely to be split between CCPs, creating directional exposures. That means clearing members might need to quickly stump up additional margin to cover mark-to-market losses on one-way exposures at one CCP, but not get any credit for mark-to-market gains on offsetting exposures at another clearer.

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