Sizing liquidity buffers for margined derivatives

Managing the unexpected OTC derivatives liquidity outflows

An industry drive towards collateralisation of OTC derivatives has sparked a shift from counterparty credit risk (CCR) towards liquidity constraints. Going forward, banks will have to closely monitor the liquidity requirements from their derivatives businesses, and can leverage their existing CCR frameworks to consistently manage liquidity risk.

Industry move towards collateralisation & impact on liquidity risk

The post-crisis era has seen a drive towards collateralisation of derivatives with the aim of significantly reducing counterparty credit risk and more broadly systemic risk. At the Pittsburgh summit in 2009, G20 leaders pledged to reform the OTC derivatives market, leading to more vanilla derivatives being centrally cleared through CCPs and the collateralisation of bilateral trades. This drive towards collateralisation, however, does not mean that derivatives portfolios are becoming risk-free. Whereas posting margin reduces counterparty exposures, it also leads to greater unpredictability in daily cash flows. Indeed, periods of high market volatility will lead to significant mark-to-market fluctuations in the derivatives portfolio, which in turn lead to greater collateral payments.

Best in class OTC derivatives liquidity management

Whilst being a good starting point for a bank’s overall liquidity management, the simplicity of the regulatory standards introduced under Basel III (LCR and NSFR) means that they are not sufficient to appropriately manage the complex liquidity risks stemming from OTC derivatives portfolios. An adequate liquidity risk metric ought to:

  1. reflect the current portfolio composition and associated risk drivers;
  2. be reactive to abrupt changes in market volatilities and their effects on potential future margin calls;
  3. take into account the effect of extreme market conditions that lead to “worst-case” liquidity outflows;
  4. provide insights into key drivers of liquidity requirements, and;
  5. forecast liquidity requirements across different time horizons (as opposed to a single point estimate).

Going forward, banks will have to closely monitor their liquidity requirements for their OTC derivatives portfolios. Financial institutions have comprehensive toolsets to monitor and manage their counterparty credit risk. We recommend that they also include liquidity metrics into these frameworks, and manage CCR and liquidity risks consistently. This article presents an OTC derivative portfolio liquidity risk framework that addresses the above criteria, enabling a “best in class” liquidity management.

How Deloitte can help

Deloitte has developed an integrated OTC derivative solution that derives the relevant exposure profiles as well as liquidity metrics for portfolios spanning a wide range of different product classes. The tool provides a unified framework with a simultaneous full portfolio revaluation, allowing for a consistent derivation of all relevant risk metrics:

  • Counterparty Credit Risk: expected positive exposure (EPE), potential future exposure (PFE)
  • Liquidity Risk: expected cash flow profile, worst-case cash-flows
  • Common XVAs: CVA, DVA, FVA
Sizing liquidity buffers for margined derivatives


Tobias Menz

Tobias Menz


Tobias is a Partner in Deloitte's Risk Advisory practice and leads the Swiss Financial Risk Management team. With over 10 years of experience, he has advised various global Tier 1 banking clients in t... More