The Impact of Margin Requirements on Voluntary Clearing Decisions

Abstract

We analyze the determinants of financial entities’ choices of whether to voluntarily designate trades for central clearing. In particular, we evaluate the impact of the Uncleared Margin Rule (UMR) on the trading and clearing decisions of firms transacting in the multi-trillion-dollar cash-settled foreign exchange swap markets. The UMR is a multi-jurisdiction rule that requires certain market participants to exchange collateral (margin) for uncleared transactions between themselves. We specifically study the effect of this rule for non-deliverable forwards (NDF) since similar contracts – FX deliverable forwards and swaps - are exempt from the rule in the U.S. and hence constitute a useful control group. In a difference-in-differences setting, we find that compared to FX forwards and swaps, the UMR resulted in firms choosing to clear a higher percentage of their swaps in the NDF market. To understand the forces behind firms’ clearing decisions, we make use of a regulatory data set that includes the identities of the parties to each swap. We show that increased clearing is due almost exclusively to the actions of clearing members, suggesting that the differential cost of clearing for these entities plays a major role in clearing decisions. Consistent with theory, we find the ability to net swap exposure at the central clearing party is one of the drivers behind the decision to clear.