Current models for clearing memberships require further enhancements to accommodate pension funds and other end investors, according to a senior buy-side executive.
Speaking at the FIA IDX conference in London, panelists debated the growth of the voluntary clearing of derivatives, and whether buy-side firms have increased their activity for both mandated and non-mandated products.
Client clearing, whereby a member bank acts as the intermediary between an asset manager and the central counterparty (CCP), is still the most actively used model, but one panelist explained the model has a way to go in order to expand cleared activity with some end investors.
“In the current client clearing model, most end users are reliant on their member to provide access. If that member doesn’t want to provide services anymore, the end user has to find a new member. If a clearing member defaults, then I would need to port their positions somewhere else,” said Robert Chin, senior managing lawyer, strategic initiatives, Insight Investment.
“If I can’t port then the clearing house will close out my position at a time and price of their choosing using my assets. Compared to the bilateral world, where I know who my counterparts is, I know the margin requirements, and I can close and reopen a position at any time, the client clearing model has further to go.”
Regulations on derivatives in the post-financial crisis era have centred around mandatory clearing of interest rate and credit default swaps in order to enhance transparency and reduce systemic risk. However, a major problem with the rules is that they were designed based on clearing factors around listed derivatives as opposed to OTC markets.
“The regulations didn’t prescribe the client clearing relationship and how it works. What many firms find now that is the clearing member is not intermediating fully, as their role has been undermined by regulation,” said Finbarr Hutcheson, president, ICE Clear Europe. “The capital elements makes it harder for banks to be intermediaries and, as a result, there is a lack of competition.”
Rosa Fenwick, director and LDI portfolio manager for BMO Global Asset Management, also warned that the current environment could lead to a clear divide between those that can clear and those that cannot.
“If you end up in a world where there is no work done on cost, you could end up with a two-tiered world where some are locked out of the clearing ecosystem. This means they have higher transaction costs, a limit set of banks to trade with, and face greater risk,” said Fenwick.
Despite these concerns, voluntarily clearing has gained pace over the last year, particularly with the onset of the uncleared margin rules. Eileen Herlihy, EMEA head of derivatives clearing sales for JP Morgan, highlighted on the panel that nearly 99% of global interest rate swaps are now cleared. In addition, voluntary clearing of repo is increasing as many are now seeing pricing benefits.
Earlier this year, Barclays expanded its client clearing business in Japan after gaining authorisation by the Japanese Securities Clearing Corporation (JSCC) to offer the service for JPY swaps trades.
In April, Deutsche Bank went live with a client clearing service for credit default swaps through LCH CDSClear, with asset management firms MEAG and Union Investment acting as the first buy-side firms to connect to the clearing house.