The Cross-Margining service effectively links the cash for U.S. Treasury securities with correlated futures products including Treasury and Eurodollar futures.

Overview

Implemented in February 2000, the Cross-Margining service effectively links the cash for U.S. Treasury securities with correlated futures products including Treasury and Eurodollar futures. This service allows for the cross-margining of cash and repo positions held at the Government Securities Division against futures positions held at various futures clearing organizations (FCOs) that process fixed-income products for all common and/or affiliated members of the two clearing organizations. This could potentially result in a significant reduction in the amount of margin a common member (or affiliate) is required to post at either clearing organization.

The arrangements are based on an agreement whereby the Government Securities Division and the participating FCO agrees to provide each other with access to any proceeds arising from the liquidation of correlated positions and associated collateral in the event of an eligible member's insolvency. Each clearing organization holds and manages its own collateral; however, the total amount of collateral collected is reduced to reflect offsets between cash and futures positions.

Who Can Use This Service

In order to participate in the Cross-Margining service, a Government Securities Division member must either:

• Be a member of a participating FCO or
• Have an affiliate that is a member of a participating FCO

The member must also sign (together with its affiliate, if applicable) a Cross-Margining Participant Agreement allowing the Government Securities Division to apply the member's margin collateral to satisfy any obligation of the Government Securities Division to a participating FCO in the event of default of the member.

It should be noted that the use of the cross-margining facility is virtually transparent to members from an operational standpoint. That is, once a member executes the cross-margining agreement, there will be no further implementation requirements.

Product eligibility differs across the various cross-margining arrangements that the Government Securities Division is party to.

Benefits

Cross-margining programs have long been recognized as enhancing the safety and soundness of clearing systems and reducing clearing system exposure during times of market stress. By minimizing the need for clearing organizations to call for large amounts of additional margin in volatile markets, cross-margining reduces the risk of a liquidity crisis of the kind that pressured clearing systems in October 1987. These benefits to the market are accomplished through:

• Providing clearing organizations with more complete data concerning the true risk of inter-market positions
• Enhanced sharing of collateral resources
• Coordination of liquidation processes in the event of a participant's insolvency

Cross-margining programs also benefit the clearing members that participate in them in a number of ways, including:

• Reduced collateral requirements for common/affiliated members
• Decreased cost of capital
• Increased liquidity
• Improved collateral management
• Lower operational costs

How the Service Works

Internal margining: Each day, the Government Securities Division and each participating FCO complete its own internal margining process to determine members' clearing fund requirements.

As a result, there may be residual long or short margin positions for members. The Government Securities Division and the FCOs will exchange, within agreed upon timeframes, daily position and margin data as to the residual long or short amounts that are made available for cross-margining offsets on a product or maturity class-by-class basis.

Cross-margin calculation: The Government Securities Division and each FCO agree on the particular products that are eligible for cross-margining treatment. The Government Securities Division and each FCO also agree on a margin formula including:

• Methodology for conversion of futures contracts to Treasury cash equivalents
• Disallowance factors, if any, to be applied

Example: The Government Securities Division's long position is less than the aggregate short position available from the FCO (line 1). After the internal calculation of margin (assumed to be at 1%) the FCO would be presented with a reduction for the available offsets (line 2).

A minimum margin is applied to offsetting amounts. In this example, the minimum is assumed to be 25% (line 3). The resulting net margin requirement of the participant is thereby substantially reduced; in this case a reduction of $1,800,000 (line 5). This example demonstrates that the margin savings on matching amounts of offsetting positions could approximate 75%.

Establishment of Guarantees: The clearing entities extend guarantees to each other in an amount equal to the cross-margining reduction.

Return of data to FCOs: The results of the cross-margining are then made separately available to the participating FCOs, so that collateral requirements of members may be reduced accordingly.

Independent Collateral Management: Margin collateral is collected, maintained, valued, and returned separately by each clearing organization pursuant to its own rules and procedures. That means that each clearing corporation determines the forms of margin that are acceptable collateral, and that both the Government Securities Division and the FCOs independently determine acceptable forms of collateral to provide sufficient liquidity to ensure orderly settlement. The arrangement does not involve the pooling of collateral between the Government Securities Division and the participating FCOs.

This means:

• The clearing corporation's ability to pledge margin collateral for liquidity purposes is unaffected
• The clearing corporation's flexibility in managing collateral is unaffected
• Coordination of margining policies and timeframes is not required
• Capped loss sharing arrangement is in place

In the event of the insolvency of a common member, the Government Securities Division and the affected FCOs would coordinate their efforts to ensure efficient and orderly liquidation. Loss sharing between FCOs would be based on applicable formulas and subject to a cap.

In the event of the liquidation of a participant, the loss-sharing arrangements between the Government Securities Division and each FCO would be proportional to the margin reductions described.