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, 3 December 2023→On the case for one-way margin
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==== On the case for one-way margin ==== | ==== On the case for one-way margin ==== | ||
In recent years — ironically, just as the “dealer” vs “customer” dynamic has become more pronounced<ref>After the [[GFC]], bank proprietary trading fell away to almost nothing.</ref> — the global regulatory-industrial complex,<ref>This label is not just sardonic: there really is a cottage industry of of “regulatory change management professionals” who owe their last decade’s livelihood to ''accommodating'' quixotic regulatory initiatives like this. They are a powerful lobby with a direct interest in maintaining the rate of regulatory churn.</ref> still fighting last decade’s war, has forged rules which overlook this. Notably, the coordinated worldwide approach to bilateral regulatory margin. As swap positions move in and out of the market, | In recent years — ironically, just as the “dealer” vs “customer” dynamic has become more pronounced<ref>After the [[GFC]], bank proprietary trading fell away to almost nothing.</ref> — the global regulatory-industrial complex,<ref>This label is not just sardonic: there really is a cottage industry of of “regulatory change management professionals” who owe their last decade’s livelihood to ''accommodating'' quixotic regulatory initiatives like this. They are a powerful lobby with a direct interest in maintaining the rate of regulatory churn.</ref> still fighting last decade’s war, has forged rules which overlook this. Notably, the coordinated worldwide approach to bilateral [[regulatory margin]]. As swap positions move in and out of the market, swap counterparties must post each other the cash value of the net market movements each day. This is a little like closing positions out at the end of each day and settling up, with a key difference: you ''don’t'' close out your positions. The parties are still on risk. | ||
Well — ''one'' of them is. The customer: the one who initiated the trade, to put itself into a market position of some sort. The other party, remember, is delta-hedged. It didn’t initiate the trade, but accommodated it, on the precise grounds that its market position would not change, and its credit position, against the customer, would be satisfactory. | |||
Requiring margin from a customer who is net out-of-the-money makes sense: if the customer fails, the dealer’s corresponding hedges are defeated and it will be left with an open market exposure to all of the customer’s positions. This is exactly what the dealer wants to avoid. It is meant to be flat. So, daily [[variation margin]] mitigates the dealer’s market risk to date; [[initial margin]] covers it for the forward market risk while it closes out its hedge portfolio against the defaulted client. As long as the dealer is covered, market disruption is minimised, and the dealer’s own solvency — which, due to its interconnection with the rest of the market may well present a systemic risk — is not threatened. | |||
Banks are not losing value on the customer positions: as per the above, they are delta-hedged. Banks have no market exposure unless their clients go bust. | Requiring a dealer to post margin to its customer against the customer’s net in-the-money position makes no sense whatsoever: | ||
Firstly, dealers are delta-hedged against every customer. They are not nursing losing positions against profitable clients. Dealers are not “the other side of the trade”: generally, they will be happy when their customers realise profits on their swaps. They do not lose money: they take another commission on the unwind, and are standing by to accept new business. | |||
Secondly, dealers and banks are capitalised and regulated for systemic risk. There are already constraints on how they must operate, and how much capital they must hold against the contingency of portfolio losses. This capital is, in part, a function of the risk the banks have to their customers. That risk is greatly exaggerated if their clients have to post cash reflecting paper gains their clients have made but not yet realised. | |||
For several reasons: | |||
Banks are Banks are not losing value on the customer positions: as per the above, they are delta-hedged. Banks have no market exposure unless their clients go bust. | |||
Banks generally go bust because their clients go bust. They don’t go bust by themselves—I know, I know, Silicon Valley Bank did, but it is an honourable exception that proves the rule. | Banks generally go bust because their clients go bust. They don’t go bust by themselves—I know, I know, Silicon Valley Bank did, but it is an honourable exception that proves the rule. | ||