Trade Ideas: Eris Exchange to Reduce Credit Risk

>> Migrating OTC Swaps to Eris Exchange to Reduce Credit Risk

Tearing up existing OTC trades and replacing them with Eris Exchange trades backed by CME Clearing mitigates credit risk and offers portfolio margin savings

The Trade

Asset Manager seeking to reduce counterparty credit risk exposure takes an existing portfolio of aged OTC swaps and migrates the positions to a CCP

Alternatives

OTC

Asset Manager agrees with existing counterparty on tear-up values and replacement trades for each position
Counterparties exchange net tear-up payment and terminate existing OTC contracts
Counterparties submit new trades to CCP via backloading process
Transactions are not publicly reported by the CCP

Asset Manager and existing counterparty perform identical negotiation of tear-up values and replacement trades, exchange of net tear-up payment and termination of OTC contracts
Counterparties submit new Eris futures contract portfolio to Eris Exchange as EFR (Exchange for Risk) transactions
Transactions are not reported publicly by Eris Exchange or CME Clearing

Implications

OTC

Asset Manager must post Initial Margin through Clearing Firm for cleared swap position
End users are not eligible to receive margin offsets between cleared swaps and futures
Eligible collateral choices have been set by final Dodd-Frank rulemakings and are generally more limited than for futures

Asset Manager can drastically reduce Initial Margin by selectively allocating existing CME futures positions for portfolio margining
Asset Manager may post IM using a wide variety of collateral, including Letters of Credit
Using Eris Benchmark contracts, liquidity at these points will facilitate future unwinds
Block trade bilateral execution is available for future unwinds over the block threshold size

Eris Exchange Savings

Savings from portfolio margining of CME futures and back-loaded Eris swap futures varies widely based on the precise positions. Below is an example of a simple 3 year swap derivative and an offsetting 3 year ED Strip.

	OTC IRS/Eris	3Y Eurodollar Strip	Total Initial Margin	6 Month Carrying Cost	Total Cost (bpa)
Cleared OTC	$908,919	$681,750	$1,590,669	$23,533	0.85
Eris Contract	$908,919	$681,750	$464,795	$6,876	0.25
Total Savings w/Eris			$1,125,874 (71%)	$16,657	0.60

Margin calculations assume $100mm notional for the Eris Exchange contracts and for each of the IR futures baskets