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Hedging exemption: Difference between revisions
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*The point of uncleared margin regulations is to ''reduce counterparty exposure'': to ensure that, should their counterparties fail, those party to uncleared derivatives are protected against bankruptcy losses for their derivative exposures. | *The point of uncleared margin regulations is to ''reduce counterparty exposure'': to ensure that, should their counterparties fail, those party to uncleared derivatives are protected against bankruptcy losses for their derivative exposures. | ||
*The ''second-best'' form of credit mitigation against a person who owes a future payment derived from a given asset is to obtain from that person the net [[mark-to-market]] value of that future payment obligation, daily, in a nice liquid store of value like cash. If you go ''[[tetas arriba]]'', I have your money, to the tune of what you owe me (give or take intra-day market moves etc). Hence this is what margin regs require counterparties to do. | *The ''second-best'' form of credit mitigation against a person who owes a future payment derived from a given asset is to obtain from that person the net [[mark-to-market]] value of that future payment obligation, daily, in a nice liquid store of value like cash. If you go ''[[tetas arriba]]'', I have your money, to the tune of what you owe me (give or take intra-day market moves etc). Hence this is what margin regs require counterparties to do. | ||
I say “''second-best'' form of credit support”, because there is a better way of mitigating that counterparty credit risk: it just isn’t usually practical in the context of OTC derivatives: A first ranking security interest over the ''actual asset that that payment is derived from''. This is the perfect form of credit mitigation. You don’t need to value it. It is mathematically the same as the | |||
This is | * I say “''second-best'' form of credit support”, because there is a better way of mitigating that counterparty credit risk: it just isn’t usually practical in the context of OTC derivatives: A first ranking security interest over the ''actual asset that that payment is derived from''. This is the perfect form of credit mitigation. You don’t need to value it. It is mathematically the same as the present of the derivative cashflow it is derived from. | ||
* This isn’t usually practical because the nature of derivatives is precisely to avoid being obliged to hold assets whose cashflows one is paying — there are learned opinions from QCs about this and everything — and the vibe of derivatives is most definitely not to give people fixed charges over assets whose cashflows you are replicating. This basically kiboshes your ability to finance your trading book. | |||
* But repackaging SPVs are unusual like that. They are always fully funded (that is what the Noteholders are for) so they don’t need to finance their trading book, and they will hold the underlying asset their swap is derived from, and ''not'' only can they secure it in favour of their counterparty, ''but they do''. The counterparty has a senior secured claim over the very asset whose cashflows the SPV is paying the return. There is no need for variation margin. Requiring the SPV to pay it would ''aggravate'', not mitigate, the SPV’s credit exposure to the counterparty. | |||
===AIFs=== | ===AIFs=== | ||
Though, trick for the young players — an AIF is a form of [[financial counterparty]], so does not qualify for the hedging exemption. | Though, trick for the young players — an AIF is a form of [[financial counterparty]], so does not qualify for the hedging exemption. | ||
{{sa}} | {{sa}} | ||
*[[Repackaging programme]] | *[[Repackaging programme]] | ||