Across the board, firms can benefit by opting to clear all FX products, mandated or not. We discuss nine of the most compelling drivers here.

• Capital Efficiency and Margin Optimization At the start of FX clearing, studies were done to assess its benefits in the context of incoming margin rules. One such study was done by Greenwich Associates titled “FX Options in the Age of Uncleared Margin Rules” in which they indicated that FX options would require significantly less margin and capital and could be approximately 86% more capital efficient than bilateral positions that need to post IM under UMR.

CCP clearing improves operational efficiency in addition to vastly improving balance-sheet positions and minimizing other regulatory capital charges, as the following methodologic, transactional, and experiential observations indicate.

– Margin period of risk (MPOR): The ISDA Standard Initial Margin Model (SIMM),
for example, uses a 10-day MPOR, whereas clearing houses (e.g., CME, LCH) use
a five-day MPOR for house-clearing and a seven-day MPOR for client-clearing, resulting in lower margin exposures for cleared trades.

– Risk-weighted assets (RWA): Basel III attributes lower counterparty risk-weights to a CCP than to a bilateral counterparty. Thus, a firm’s RWA and leverage ratio profiles benefit, and the netting effects of consolidating positions against a single counterparty contribute to reducing overall capital requirements.

– In addition to clearing bilateral products, firms clearing listed FX options through a CCP benefit from risk-offsetting and cross-margining methodologies by which their overall IM requirements decrease significantly. Given the UMR changes and that firms have experienced a deterioration in the quality of bilateral FX options quotes, many traders now consider listed FX options as a viable alternative for managing their OTC portfolios.

– To effectively select whether to use a cleared or uncleared channel and assess potential capital-reduction benefits, firms increasingly want the capability to simulate pre-trade IM at the portfolio level in real time — directly within their systems.

• Netting/Compression Compression eliminates economically redundant derivatives positions and thereby reduces outstanding contracts. CCP-enabled FX blending further reduces the number of open trades while keeping the original risk profile the same and contributing to operational efficiency.

Tools help firms perform multilateral netting that:

– Reduces both gross and net notional positions

– Enhances capital efficiency and leverage ratios

– Helps manage counterparty credit risk

– Reduces operational risks and costs

Fewer line items require less reconciliation and reduce netted settlement. Multilateral netting enables firms to hold a single position per instrument (e.g., CCY Pair/Settle Date), rather than servicing individual lines with each bilateral counterparty and holding complex ISDA master agreements and/or credit support annexes (CSA).

• No Disputes, Less Management CCPs use standardized market data per industry best practice to calculate Variation Margin (VM) and Price Alignment Interest (PAI), and a robust risk methodology to calculate IM. This discipline eliminates disputes on VM and IM calls versus bilateral trades.
• Settlement Netting Utilizing a single clearing agreement provides access to the full liquidity available in FX futures and options and eliminates the need for complex ISDA agreements and/or CSAs with multiple bilateral counterparties.
• Settlement and Trading Platforms Support CLS delivers settlement, processing, and data solutions launched by CLSClearedFX — the first Payment-versus-Payment (PvP) settlement service specifically designed for OTC-cleared FX derivatives. The CCP CLS unique cycle provides settlement certainty and netting benefits for OTC FX and cross-currency swaps members. Therefore, CCPs and clearing members can settle cleared FX products safely and effectively.

• Operational Efficiency For those firms using self-clearing, CCP clearing can provide an effective mechanism to:

– Free up bilateral credit lines

– Access more liquidity providers

– Achieve netting for daily settlements

– Automate the trade allocation process

Buy-side firms can aggregate their positions in a single account directly with a CCP or via a futures commission merchant (FCM). This reduces settlement risk as most CCPs use CLS’s PvP whereby all settlements are netted across positions by currency.

• Cheapest-to-Deliver (CTD) Collateral While keeping a minimum margin level is critical, a key goal is to minimize collateral cost with CTD collateral. CCPs allow firms to post a variety of collateral, whereas bilateral CSAs limit collateral types (including government securities, ABS, MBS, and corporate bonds). Some CCPs are using real-time collateral optimization through Euroclear Bank, offering collateral allocation and substitution for FCMs and end users.
• Ringfencing Collateral CCPs support various models such as the individual segregated model (asset seg/value seg), which allows firms to ringfence non-cash collateral and help safeguard underlying collateral from defaulting. These structures facilitate the porting of trades facing the defaulting FCM.
• Portfolio/Cross-Margining and Capital Reduction Regulatory bodies have authorized CCPs to conduct portfolio margining across exchange traded derivatives (ETD) and OTC FX products. Trading in a regulated, transparent, all-to-all marketplace with firm liquidity offers attractive qualitative benefits. Quantitatively, it also helps reduce counterparty credit risk (CCR). According to the CME Group, a listed FX Options portfolio reduces IM to 0.8% of notional compared with 2.6% of notional for a comparable portfolio with bilateral SIMM requirements. This approach results in a cost differential of 595%, as delineated in the following exhibit from the CME’s article titled “Listed FX Options: A Capital efficient, Low-cost Solution”.