New regulations requiring traders to post initial margin when clearing swap contracts through clearinghouses and outside of clearinghouses will cost financial firms $1.4 trillion in new capital charges, according to a research report released on Monday by Tabb Group.

That $1.4 trillion relates only to interest-rate contracts which make up the largest portion of the $600 trillion global swaps market. And the figure could be a conservative estimate. It could actually reach as much as $2 trillion.

"Although dealers have readily adopted clearing for the most vanilla segment of their OTC derivative portfolios, these exposures require comparatively little margin since they represent the creme of the proverbial crop," says E. Paul Rowady Jr, a senior analyst at Tabb Group who authored the report entitled "Initial Margins for OTC Derivatives: The Burden of Opportunity Costs.

For so-called exotic derivative positions and smaller portfolios held by a majority of "other end users" -- typically fund managers and corporations-- the initial margin requiremetns will range from "painful" to the "outright extinction of some types of trades.

Rowady warns that firms should not count on margin offsets to mitigate initial collateral requirements by a significant amount. That is because maximizing capital offsets is dependent upon a clearinghouse's ability to see all positions. That's not feasible in a world with multiple clearinghouses.

"When various product positions like cash bons, futures and OTC swaps are spread across multiple clearinghouses, the potential benefits of margin offsets become diluted," says Rowady. "This is the cost of clearing fragmentation, and it is the main impediment to achieving maximum margin offsets while maintaining the same high level of systemic risk control."

-- This article first appeared on Securities Technology Monitor.



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