Trade funding costs hit by increasing interest rates and margin needs, finds research

Margin increases of more than 30%, as well as the UK base rates jumping from an historic low of 0.1% to 1.25%, are having a significant impact of the cost of funding for trading.

Derivatives analytics firm OpenGamma has conducted research which finds that increasing margin requirements and rising interest rates are having a significant impact on the cost of funding for trading.

According to the findings, margin, upfront cash or collateral which firms need to post before entering into a trade, currently sit at £927.50 for one-month Sterling Overnight Index Average (Sonia) futures – a margin increase of 30% in just two months.

Similarly, the margin requirements on the one-month Euro Overnight Index Average (Eonia) contract have increased by more than 100% since the beginning of this year.

Alongside the increase in margins, interest rates have also gone up for various currencies over the last few months. The UK base rate has seen rapid increases from a historic low of 0.1% to 1.25%, coupled with a tenfold increase in the Fedfunds rate from 0.08% to 0.83%, which has resulted in rates on US dollar and sterling shooting up to 10 times higher than they were at the beginning of this year.

Last month, the US Federal Reserve raised rates by 75bps, less than the 100bps that some were expecting, whilst in a surprise move the Swiss central bank also jumped in with its first increase in 15 years, hiking 50bps to move from –0.75% to –0.25%.

“If market participants are using a flat rate, or just considering the spread funding cost calculations, then the main impact will be any increase in requirements,” said Jo Burnham, risk and margining expert at OpenGamma.

“However, as interest rates continue to rise, then it is likely that the flat rate applied, or appropriate spreads, will also need to rise. The spread applied to a rate of 0.5% is going to be lower than the spread you would apply if the rate increases to 3%, for example.”