The trials of separation
Despite a likely
delay to the enforcement of new OTC derivatives rules in Europe, Renaud Huck
and Stuart Heath at Eurex believe buy-side firms must soon make decisions on
how best to protect their clients’ assets.
the buy-side the ability to legally and operationally split their collateral
and exposures from other clients of the same general clearing member within a
clearing house. Eurex, which is the derivatives exchange owned by Deutsche
Börse, has offered segregation for the listed derivatives it clears since last
“Our intention is to extend
the fully segregated service we offer for listed derivatives for the OTC
derivatives we plan to clear, which will offer the buy-side the highest level
of protection for their swaps exposures,” said Heath, who heads Eurex’s
representative office in the UK.
European market infrastructure regulation (EMIR), many bilaterally traded swaps
will be standardised so they can be centrally cleared and traded on exchange-like
platforms. Article 37 of EMIR requires central counterparties (CCPs) and their
clearing members to offer the buy-side ways for them to segregate their
collateral and positions.
While Eurex has
begun engaging with institutional investors, other CCPs stand accused of
providing insufficient detail on segregation arrangements, thus hampering
preparations for the new rules.
segregation model splits the collateral and positions of each fund that uses
the clearing house from other participants. This means that the exposures of
each fund are kept separate from their clearing members and CCPs, allowing them
to easily port positions to other entities in the event of a default.
that the need for segregation lies more with the risk associated with the
clearing members themselves, rather than CCPs.
“Each buy-side fund could have
more than one clearing member associated with it, so although only part of that
portfolio is at risk, you don't know who the other clients of that clearing
member are,” he says. “You could be the most conservative fund in the world but
there is no transparency as to what
other entity is in the same pool and the risks they may pose.”
Eurex also plans
to offer an omnibus segregation option that will bear similarity to the “legally
separated, operationally comingled” approach detailed by US regulator the
Commodity Futures Trading Commission.
approach, all of a buy-side’s fund exposures, as well as those of other
buy-side firms in some instances, are separated from clearing member
contributions. If a clearing member defaults, positions and collateral can only
be transferred to another firm if all clients in the pool agree, which is
“Ideally, all firms would opt
for full segregation but it can prove quite expensiveand operationally
cumbersome, particularly for those buy-side firms that run a large number of
funds,” says Huck, head of UK institutional investor relations.
Eurex has also
begun work on deciding which products it will consider eligible for clearing.
This is a process each CCP will be required to carry out in conjunction with
regional watchdog the European Securities and Markets Authority (ESMA).
CCPs will first
need to decide what they are able to clear and then seek final approval from
on 31 May that it plans to rollout EurexOTC Clear for interest rate swaps, the
largest and generally most liquid type of swap, in the second half of this
year. The launch will be supported by
Barclays, BNP Paribas, Citibank, Credit Suisse, Deutsche Bank, J.P. Morgan and
Huck says the
main driver for clearing other instruments is risk.
“Our primary consideration
when deciding what should be made clearing eligible, is whether we are on a
position to accurately value and assign a daily mark-to-market price for OTC
derivative instruments,” says Huck.“There are a number of instruments that do
not trade frequently and are relatively illiquid, and would therefore hamper
our ability to effectively manage risk.”
Although some buy-side
firms continue to express concern at the increased cost of doing business in
the new, cleared world, Heath believes most are now preparing for the
regulation in earnest.
“The buy-side now seem more
concerned with the operational aspects of the rules, rather than the overall
impact of the clearing obligation,” he said. “While it’s hard for the buy-side
to have a full understanding of this given the regulatory uncertainty, they are
taking steps to choose their partners in the new world.”
While the G-20
wanted new derivatives rules to be in place for the start of 2013, Patrick
Pearson, head of financial market infrastructure at the European Commission,
stated last week that Europe was unlikely to begin clearing by this time.