TriOptima launches counterparty risk reduction service
Regulators across the globe are pushing standardised over-the-counter derivatives to be cleared by central counterparties to reduce systemic risk. Not all trades will be eligible for clearing, though, and many asset classes will migrate to a range of different CCPs – a fragmentation that will prove costly for dealers.
Splitting up derivatives portfolios reduces the risk offsets that dealers enjoy by having all of their trades in one netting set. This means banks will have to hold more capital and post collateral against exposures to multiple clearing houses as well as positions that remain outside clearing.
The launch of new service triBalance seeks to address these potential counterparty risk imbalances by suggesting offsetting trades for dealers to execute.
“As trade volumes in asset-specific CCPs grow, the ability of banks to net counterparty exposure across asset classes under an ISDA CSA [contract] diminishes and the counterparty exposures become unbalanced,” said Peter Weibel, CEO of triReduce, the portfolio compression service run by TriOptima.
“triBalance promotes the efficient use of collateral and capital which helps market participants manage their risks. But we believe it also strengthens overall financial stability by reducing credit risk exposure, which is a key goal of the regulators,” he added.
Splitting up netting sets can be extremely costly for banks. Take this example where Bank X owes Bank Y US$50m on an interest rate swap but is owed US$50m on a credit default swap. These trades cancel each other out in the uncleared world and therefore no collateral needs to change hands.
If the CDS and interest rate swap are moved into different clearing houses, though, the netting efficiencies disappear: Bank X would have to post US$50m of collateral to a CCP clearing interest rate swaps, while Bank Y would have to post the same amount to a CDS clearing house. These payments could be on top of margin and capital the banks may have to allocate to cover their overall exposure to the clearing houses.
Similar inefficiencies arise between structured swaps that won’t be eligible for clearing and the vanilla swaps used to hedge these positions that will be cleared by CCPs.
In pilot testing, triBalance reduced counterparty risk exposure in participating banks’ portfolios of cleared and uncleared trades by 33%. In total, the service generated a reduction of US$2.7bn in potential future exposure assuming a move of 10bp in interest rates in the market. This risk reduction would be even greater in times of extreme market volatility, TriOptima said.
To do this, participating banks are asked to send TriOptima the risk profile of their bilateral counterparties and their CCP exposures. triBalance then uses algorithms to identify a set of new trades for each participating member to execute. This set of trades will reduce the bank’s exposure to its clearing houses, as well as its bilateral exposures to other banks that arise from trades that are ineligible for clearing.
“These are purely risk-reducing trades that bring down the counterparty risk in both the cleared and uncleared world. The savings will be meaningful, reflecting each participant’s counterparty risk exposure profile which is translated into initial margin requirements from its CCPs,” said Weibel.
Nine of the major dealers supported the pilot and the first live cycle should be executed within the next two months. With counterparty credit risk management and collateral optimisation increasingly important for derivatives dealers, the service may well become a mainstay of the risk management toolkit for banks going forward.