The Efficiency of Counterparty Netting in OTC Derivatives

How Clearing Solves the Uncleared Margin Puzzle


The phase-in period for initial margin on non-cleared derivatives began on September 1, 2016 for Financial Counterparties who are subject to the regulations of participating jurisdictions. This paper uses interest rate swaptions as a worked example of the counterparty netting impacts. When CME Group began clearing interest rate swaptions on April 11, 2016, multiple banks were quoted as saying that these uncleared margin rules would be drivers of voluntary swaptions clearing.

The analysis to date of margins for cleared vs. uncleared has focused primarily on the side-by-side comparison of the Standard Initial Margin Model (SIMM) vs. the CME margin model. This comparison only tells part of the story, with the missing piece being one of the most important efficiencies of clearing: counterparty netting.


One of the primary reasons why clearing is superior from a margin efficiency perspective is the counterparty netting, rather than any model differences.

For example, Bank ABC trades swaptions against 10 dealer counterparties and all of these entities are Financial Counterparties subject to the September 1, 2016 compliance date. In the new regime of uncleared margins, the portfolios that Bank ABC has with each of these 10 dealers are treated as 10 separate portfolios that are margined independently.

For the sake of a clean comparison, we’ll use the CME historical value at risk (HVAR) margin model to calculate both the cleared and uncleared margin requirements. This is important because it eliminates any noise of one model being advantageous over another and allows the isolation of the counterparty netting benefit.


We created 10 portfolios to simulate Bank ABC’s swaptions positions with each of these 10 counterparties.

To simulate the margin implications, we ran the portfolios through two scenarios. In the uncleared scenario, each of the 10 portfolios is margined separately, replicating the conditions of the dealer having to post bilateral margin to each counterparty.

The total margin required to post is $1.7 billion.

Exhibit A – Bank ABC’s uncleared swaption margins with 10 separate counterparties

Portfolio # of Trades Margin Result
Uncleared Counterparty 1 235 $182,489,622
Uncleared Counterparty 2 430 $64,758,273
Uncleared Counterparty 3 159 $421,680,284
Uncleared Counterparty 4 130 $225,687,930
Uncleared Counterparty 5 469 $320,184,602
Uncleared Counterparty 6 476 $31,007,151
Uncleared Counterparty 7 112 $33,604,900
Uncleared Counterparty 8 501 $165,404,511
Uncleared Counterparty 9 464 $148,804,368
Uncleared Counterparty 10 330 $130,585,625
Total 3,306 $1,706,207,267


Now let’s assume that Bank ABC clears all of the swaptions in these 10 portfolios at CME Group. The swaptions positions of Bank ABC are unchanged, but they are now margined in a single account, so margins are charged on a net portfolio basis.

Exhibit B – Bank ABC’s swaption margins as a single cleared portfolio

Portfolio # of Trades Margin Result
Single Cleared Portfolio 3,306 $375,989,781

The results show that Bank ABC would have to post $376 million, which is only 22% of the uncleared margin requirement. To put it another way, Bank ABC would have to post uncleared margins that are 4.5 times higher than the CME cleared margins for the same exact swaptions positions.


There are various other benefits of clearing swaptions including the margin efficiencies of swaptions against offsetting swaps and futures in the same portfolio, the operational simplicity of only facing one counterparty,  the variation margin funding benefit of only one exchange instead of funding/receiving in multiple exchanges and the advantageous capital treatment of holding positions at a Qualifying CCP. For the same logic mentioned above, these additional benefits are not considered in this analysis, so we can isolate the counterparty netting benefits.


Quantifying the margin efficiencies generated by counterparty netting inside of clearing helps explain one  of the reasons why banks are so enthusiastic about the clearing of non-mandated products such as swaptions, MXN swaps and BRL swaps. As noted previously, this analysis intentionally ignores additional capital efficiencies and margin savings of clearing products such as swaptions along with offsetting interest rate swaps and futures, so the actual total savings would likely be significantly higher than portrayed in this paper.

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