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Initial Margin: When Does More Turn Out to Be Less?
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IvySchmerken
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IvySchmerken,
User Rank: Author
8/1/2014 | 12:37:21 PM
Re: Disputing a Margin Call on OTC Derivatives
Paul, Thank you for clarifying the word "dispute."

I was not clear if firms can actually disagree with or dispute their margin calls or collateral calls. I think your point t that risk is not eliminated but is transformed is an important one.
PaulJ519
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PaulJ519,
User Rank: Apprentice
8/1/2014 | 12:31:11 PM
Re: Disputing a Margin Call on OTC Derivatives
Thanks Ivy - your point about complexity is well made.

Allow me to clarify my wording - you cannot dispute ccp collateral calls - you must pay them otherwise you are in default. 

Once the bilateral margin rules for margin come into force in Dec 2015 and firms start to use risk model to calculate Intial Margin then disputes on illiquid derivatives could cause operational challenges which may in turn affect banks balance sheets.

 

 

 

 
PaulJ519
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PaulJ519,
User Rank: Apprentice
7/30/2014 | 4:08:06 PM
Re: Disputing a Margin Call on OTC Derivatives
To your first point - It depends on how you define the word "dispute". In the strict definition you can't dispute a CCP margin call, you just pay and then challenge afterwards. This is a key difference relative to non-cleared derivatives.

To your second point - My view is that risk will never be fully removed as it is in the nature of our economic model and is required to support growth. The question is, where it sits - in end-users' balance sheets (eg if they stop hedging with OTC derivatives), on banks' balance sheets (which causes problems if they misprice and understate risks) or within CCPs.

Most often risk is not eliminated but transformed; for example, long-term credit risk may be turned into short-term funding liquidity risk through the use of collateral agreements. This type of risk may cause losses to be realised much more quickly, giving firms less time to respond. Warehousing illiquid assets is a core function of banks' balance sheets and regulators and banks work hard to ensure they are appropriately capitalised and managed.

 
IvySchmerken
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IvySchmerken,
User Rank: Author
7/29/2014 | 10:40:59 AM
Disputing a Margin Call on OTC Derivatives
Paul, Thank you for pointing out the differences in calculating initial margin for cleared vs. non-cleared OTC derivatives, which certainly  is a complex topic. I've seen various headlines speculating on the safety of CCP model, asking what if a counterparty defaults. From what you said, I gather that if a counterparty disputes an initial margin call, this will hold up payment to the CCP. Can this be risky to the entire CCP and its other participants?

In your second example, with non-cleared OTC derivatives, these instruments are too illliquid to be placed in a CCP. So it seems like the bank's balance sheets are still at risk. And with the non-cleared OTC derivatives, it seems that the banks themselves are calculating initial margin based on models standardized by ISDA, but there are still differences in calculations. Do you think enough risk has been taken out of the system?


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