As the market is well aware, initial margin will be charged on both cleared and non-cleared OTC (for large dealers by Sep 2016). This ties up large amounts of high quality collateral which in turn creates a significant funding and capital costs for holding OTC positions. Initial margins will be charged by the CCP daily for the full holding period of the trade (potentially to maturity) and it is this long-term nature of initial margin that makes these costs difficult to estimate.
Over the last year OpenGamma has collaborated with researchers from UCL to investigate various aspects of margin valuation adjustment. This research is only one part of the work we are doing in this area, and will help us to bring practical solutions to the problems that our customers face today.
OpenGamma already provides a module for calculation of initial margin on pre-defined future pillar dates (Forward IM) as part of the OpenGamma Margining solution– which is used as a workable proxy to estimate lifetime margin cost using a single path for future rates. We are now working on an update to this solution that will to introduce probability weighted future paths for market rates to introduce the dynamic nature of IM under different future rate environments. We intend to test the impact of this specific effect between the various CCPs to understand differences in margin outcome if the market were to go through a period of higher volatility.
The research with UCL has focused on a more advanced approach to directly calculate dynamic IM as part of the simulation of the future market state: IM is computed as a value-at-risk (VaR) or Expected Shortfall (ES) directly from a model. Rather than reproduce the exact procedure used by the CCPs, the approach computes the risk measure in a way coherent with the underlying market model. This provides for very efficient estimation of the future IM. You can read a summary of some of the results here.