May 30, 2012
OTC clearing under fire as buy-side condemns cost hike
Central clearing for OTC derivatives does not make for a
safer market and may increase costs for end-investors, Barry Hadingham, head of
derivatives and counterparty risk, Aviva Investors, has warned.
Speaking at the TradeTech Swaps and Derivatives conference
in London yesterday, Hadingham called into question post-financial crisis
reforms such as the G-20 commitment to standardise and centrally clear OTC
derivatives. Prompted by host Anthony Belchambers, CEO of trade body the
Futures and Options Association, who made a comparison between the costs of
clearing at a central counterparty (CCP) and driving a Rolls Royce, Hadingham admitted
expense was a serious hurdle for buy-side firms.
“Where the primary risk is counterparty risk, the CCP is the best place to manage that, but where the risk is directional, [i.e. exposure to the direction of
movements in major market variables] then we have to seriously consider if the costs of clearing outweigh the benefits,” he said. “A lot of asset managers are saying it could simply be too expensive to operate in these markets.”
In Europe, the upcoming European market infrastructure
regulation (EMIR) aims to standardise as large a proportion of current OTC
derivatives as possible, so they can be centrally cleared. EMIR is currently
being developed by the European Securities and Markets Authority, which has
been assigned to detail some 30 technical standards so that the regulation can
be implemented by the end of the year.
However, Hadingham believes that the new rules would create
prohibitive costs in the form of default fund contributions, which would then
be passed on to end-investors. He also suggested that CCP clearing may not
remove systemic risk from financial markets as effectively as politicians and
regulators hoped.
“It should be recognised that by moving into OTC clearing, we are moving counterparty risk around, rather than removing it
completely,” he said. “Prevention is preferable to a cure. But I am concerned
at what the final cost to neutralise risk will be once standardisation and
central clearing takes effect.”
Belchambers suggested that with post-trade costs likely to
rise as more contracts are brought onto central clearing, the economic viability
of smaller, lower-volume asset managers continuing to operate in derivatives
markets is being severely tested – especially given already depressed trading
volumes and reduced revenues at many financial institutions.
“The costs don’t stack up in many cases,” he said. “The
smaller firms will undoubtedly leave if they cannot justify the cost of
continuing in this space.”
Cheap and cheerful
However, other participants at the TradeTech event suggested
that OTC derivatives reforms would benefit market participants in the longer
term. Jane Lowe, director of markets at the Investment Management Association, pointed
to the benefits of increased standardisation as a means to promote more
efficient, “cheap and cheerful” trading in derivatives markets.
“As commoditisation of OTC derivatives occurs, automation
will increasingly reshape services and who provides them,” she said. “This
reform will benefit all investors, while anonymity and standardisation of
contracts can help boost liquidity. I see positive changes ahead.”
According to Lowe, market participants will have to either
accept higher basis risk from using standardised derivatives contracts, or pay
more for a bilateral contract that will provide a more exact solution. Under
EMIR, bilateral OTC derivatives contracts will still be available, but will be
subject to significantly higher margin requirements.
However, Ido de Geus, head of treasury and client portfolio
management at Dutch investment management firm PGGM Investments, remained
determinedly sceptical about the prospects for buy-side firms operating in
derivatives markets.
“If clearing gets in the way of hedging risk, people will
either go bilateral, or simply not use so many derivatives contracts at all,”
he said.
While the deadline for EMIR implementation has been set for
the start of 2013, as per G-20 commitments, Patrick Pearson, head of financial
market infrastructure at the European Commission, revealed on Monday that the
clearing obligation for firms in Europe will be delayed.
Elliott Holley
+44 (0)20 7397 3820
elliott.holley@information-partners.com