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When It Comes to Clearing, Go Big or Go Home

| FinReg

By Sol Steinberg, OTC Partners

Originally published on TABB Forum 

There are a lot of OTC derivatives clearing providers screaming for recognition in the marketplace, but nothing speaks louder than true industry validation. 

As financial technology evolves at an ever-increasing rate, new software vendors spring up like dandelions in summer. At the same time, existing providers take advantage of opportunities to expand into new verticals. While this innovation undoubtedly helps move the industry forward, it clearly adds an element of operational risk, as a multitude of unproven systems tout themselves as practical solutions.

This is particularly true in the complex arena of central counterparty clearing for OTC derivatives. Fortunately, there is a way to mitigate this risk.

New participants can develop and demonstrate powerful systems, but – regardless of how many bells and whistles they may offer – nothing speaks louder than true industry validation. By that, I am talking about accreditations such as LCH.Clearnet’s CCP2 certification program. As one of the architects of CCP2, the industry’s first certification program, I witnessed first-hand the difficulties encountered by investment firms as they sought technology partners to assist with clearing.

After the Lehman Brothers debacle, we saw an urgent need for a standardized certification program. The clearing world needed some sort of verification process that would help avoid further information leaks and prevent another massive collapse.

One part of the equation was regulatory, so we designed the program to help market participants comply with the new wave of CFTC requirements. The other important aim was to guarantee that a given provider is knowledgeable and possess demonstrated expertise with the correct systems and methods involved with OTC clearing. This is far more complicated and important than it may sound.

Margining, for example, is an extremely complex process, made even more difficult by the variations in margin rules employed by different brokers. However, with the ability to certify margins accurately, firms can know their precise requirements and, therefore, achieve far greater capital efficiency. This makes more money available for trading and could potentially produce billions of dollars in annual savings.

The benefits go beyond the clearing industry. An increase in capital market activity is essential to create economic growth, and when the U.S. economy grows, the world economy benefits.

Having spent my entire career working with OTC derivatives, I cannot emphasize enough how important it is to select a software provider that understands the intricacies of central counterparty clearing. This is especially true now, as regulatory mandates continue to increase throughout the financial sector, dramatically heightening the complexity of an already complicated process. With swaptions clearing set to begin in the not-too-distant future, the severity of this issue cannot be understated.

That’s why when it comes to choosing the right technology vendors, the first question should always be: “Are they certified?” Think about it – you wouldn’t choose an unaccredited doctor or an unlicensed pilot, so why would you expose your investment operations to the risks inherent in choosing an uncertified software provider?