How Much Is Central Clearing Really Costing You? Part 2
By Jennifer Liu, Capco
Originally published on TABB Forum
Compared with direct clearing members, clearing brokers face higher charges from CCPs, service providers, settlement banks, and CSDs. They also operate at a higher cost, with both client and house transactions to be managed.
This is Part 2 of a three-part series exploring the cost of central clearing to various market participants and potential ways to reduce the cost. Part 1 focused on direct clearing members (DCMs). Part 2 focuses on the clearing brokers’ (GCMs and FCMs) perspective.
Given membership requirements, not every firm qualifies to be a direct member of a CCP. Some banks/dealers set up infrastructure to offer the clearing services to those that can only qualify as indirect members. There is no secret in the industry that the clearing business is generally not a revenue generator but helps to build and maintain client relationships. Again, cost is crucial in ensuring a sustainable business model.
Clearing brokers can be either General Clearing Members (GCMs) or Futures Commission Merchants (FCMs). GCMs usually follow a principal model, in which they book back-to-back transactions with clients and clearing houses, thus taking a principal role in the transactions. FCMs, on the other hand, follow an agency model in which they guarantee clients’ performance and step in when clients default but otherwise are not directly involved in the day-to-day transactions (except margin handling). Differences aside, the following cost structure in Diagram 1 for clearing brokers applies generally to both GCMs and FCMs.
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Table 1, below, compares the cost components between DCM and GCM/FCM.
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Compared with DCMs, FCMs/GCMs face higher charges from CCPs, service providers, settlement banks, and CSDs given the client transactions involved. They also operate at a higher cost, with both client and house transactions to be managed. In addition, FCM/GCMs need to worry about the capital charges they may incur given the client transactions on their books.
FCMs/GCMs pass on the clearing fees to the clients and margin clients based on the methodology provided by the CCPs, with margin premiums sometimes charged to the clients to manage their credit profile. They charge clearing commissions to the clients that intend to cover the cost of handling client transactions. However, it is unclear if all the cost components are factored in. A good guess is ‘no’ for the majority of the FCMs/GCMs. If this is the case for your firm, it is time to take a closer look at the clearing cost and pricing model.
In the last installment of this series, the author will share her thoughts on managing clearing costs and potential ways to reduce them.