Options markets to get liquidity boost

Matt Raebel

Matt Raebel



A new rule finalized last month by the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency might make it easier for banks and brokerages  to keep less capital tied up, potentially clearing the way for them to do more business with market makers.

In late November, these regulators jointly finalized a rule that would implement the “standardized approach for measuring counterparty credit risk,” also known as SA-CCR (pronounced “SACK-er”). The rule was originally proposed in October 2018, but the final version was revised in response to feedback from various financial institutions, such as the Options Clearing Corporation (OCC). Don’t you just love it when regulators and the regulated get along?

The news was well-received from individuals and organizations throughout the derivatives industry, especially on the clearing and settlement side. The OCC’s Executive Chairman Craig Donohue said the action addressed complaints that the OCC and others in the listed options business have made to policymakers for years. 

“We appreciate the agencies’ work to finalize this important measure,” he said in an official statement, “which will enhance the ability of firms to offer clearance and settlement services to market makers and other liquidity providers who are vital to the functioning of the U.S. listed options market.” FIA’s President, Walt Lukken, voiced similar praise in an official statement: “FIA is pleased with the provisions in the final rule that recognize the exposure-reducing nature of client clearing under the leverage ratio for cleared derivatives, and the provisions designed to mitigate the impact on end-users.”

The SA-CCR is a tool for calculating total risk-weighted assets (RWAs). To put it simply, if you’re a bank handling a derivatives trade, the SA-CCR is the methodology by which you figure out how much capital you need to set aside to cover the trade in case your partner doesn’t meet their trading obligations and leaves you holding the check. The SA-CCR mainly applies to financial institutions with assets worth $250 billion, or with annual foreign exposure totaling more than $10 billion – basically, only the biggest banks, brokerage firms, and so on are actually required to use the SA-CCR. Other banks have the option to use it for their benefit as well. 

The rule used today, the Current Exposure Method (CEM), is a less risk-sensitive method considered by many – especially those in the options world, like Angelo Evangelou, chief policy officer at Cboe – to be flawed. For example, under the CEM, brokerages were required to allocate just as much money to cover out of the money options, which are unlikely to be exercised, as in the money options. “You can have an option that is practically worthless, out of the money; under CEM you would have the same capital charge as an in the money option,” Evangelou said in a phone interview. “That just shouldn’t be.” According to Evangelou, the SA-CCR also gives market makers more flexibility by more effectively accounting for strategies such as netting and delta weighting of options positions. 

Although Evangelou admitted he wasn’t sure exactly how the SA-CCR will change things for those outside the listed options world, those inside of it – especially market makers – are chuffed. “In our industry, within our space, folks are very happy – especially in the market-making community now that there’s certainty that migration to SA-CCR is set to happen. It should be beneficial to liquidity in the options department.”

Enthusiasm for the new rule isn’t by any means absolute or universal. The International Swaps and Derivatives Association (ISDA) conducted its own study on the SA-CCR, which they published in May. The study, which was entitled, “SA-CCR: Impact on the US,” attempted to assess the potential impact that the SA-CCR might have on U.S. markets and financial institutions. The study said that its findings contradicted information cited by U.S. regulators; instead of the SA-CCR’s adoption resulting in a decrease in exposure at default and counterparty credit risk when compared to the CEM, the ISDA report said that the SA-CCR would cause exposure at default to remain comparable to how it was under the CEM, while counterparty credit risk RWAs would increase substantially. The study said this warrants further analysis, as these and other factors could actually result in higher costs and capital charges under SA-CCR.

Although the SA-CCR primarily applies to large financial institutions, its implementation will have effects that will ripple throughout the finance industry. Ultimately, experts are sticking to a “wait and see” mentality. Evangelou described the feedback he’d heard from others in the industry as “cautious” optimism.  

The SA-CCR is scheduled to go into effect in April 2020. 

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