Crunch Time for Clearinghouses as Regulators and Participants Shift Focus

By Radi Khasawneh, TABB Group

Originally published on TABB Forum 

The concentration of risk among central counterparties in the new global market structure must be accompanied by a proportional increase in transparency and reporting at the CCPs. 

We are at the implementation phase of a global regulatory shift that will force the majority of swaps into clearing. The idea behind the push was to give regulators a cleaner view of risk in the derivatives world; but ever since the intention was announced by the G20 in 2009, market participants (Lloyd Blankfein among them) have long been concerned that this in itself may be creating additional systemic risk.

After all, if most trades have to go through a limited pool of central counterparties (CCPs), the potential for a significant market shock increases. Conceptually, there are safeguards to prevent this concentration of risk in a handful of venues. Future Commission Merchants (FCMs) that facilitate clearing demand and post margin, and all clearing members contribute to the default funds that are there to minimize the fallout of a default.

TABB Group’s view has been that there is not necessarily a problem with this; but that the increase in the importance of CCPs in the new market structure must be accompanied by a proportional increase in transparency and reporting at the CCPs. Many of the safeguards are dependent on proprietary and often opaque modelling. They are owned or operated by a mixture of dealers and exchanges, meaning that everyone’s risks should be aligned – but a further level of assurance is necessary.

News earlier this month that indicated that two leading clearinghouses have agreed to provide additional disclosure on their default fund and all-important margin requirement models is therefore highly encouraging. This paves the way to the establishment of a formal disclosure standard by the International Organization of Securities Commissions (IOSCO) later this year.

This will go a long way to alleviating the still glaring differences in global clearing margin requirements and disclosure standards, analyzed in a recent TABB Group report, “Global Collateral Standards 2014: Breaking Through Regional Silos.” In that report, we pointed out that short-term fragmentation (with multiple entities split geographically) was likely to give way to consolidation and standardization over time. Regional clearinghouses cannot simply do their own thing and march to the local regulator’s tune, and huge differences remain in margin treatment globally (see Exhibit 1, below).

TABB 7 21 14 

Sources: Company reports, TABB Group 

It is far more preferable that this comes from the clearinghouses themselves and, in fact, the efforts of many global clearinghouses to attract increasing flow across different products in order to boost margin efficiencies increases the complexity of the modelling question, making it even more crucial.

This is an inherently healthy process, but there are problems. Primarily, the problem is a political one, and the lack of clear progress on the issue of equivalence between the US and Europe is a particular concern. In June, comments on a panel at the IDX conference by the CFTC’s Ananda Radhakrishnan caused a stir when he said that he was tired of granting cross-border clearing exemptions for European CCPs, and that it would be simpler if they moved clearing operations to their jurisdiction.

So where does that leave us now? We still believe that standardized and periodic disclosure within a global and equivalent framework is the most likely outcome – probably facilitated by an increase in global tie-ups and cooperation agreements between the CCPs themselves. The need for assurance on the systemic issue is critical to all, and the CCPs themselves have begun to more stridently make the case for the benefits of the new system. Last week, Eurex (owned by Deutsche Boerse) published a white paper laying out the benefits of the new system versus the bilateral model. This in itself merely supports the moves by global governments to date, and increased transparency into risk models will help the case.

This all is a sign that CCPs are getting more used to the idea of operating in an open environment, a welcome and necessary step. A bit of pragmatism on all sides will go a great way to untangling the balkanized system we have today.