Clearing Models Evolve

Terry Flanagan

Derivatives clearing organizations (DCOs) are implementing a new clearing model that is seen as being in conformance with regulatory reforms on both sides of the Atlantic.

The model provides for client assets held by a clearing member to be fully segregated from the clearing member’s assets and assets of the clearing member’s other clients.

“As a matter of both risk management, keeping up with competition and compliance with the proposed regulations, I believe the former model of using omnibus accounts with no legal segregation of funds will be history,” Trish Rogers, co-chair of the financial institutions group at Moye White, told Markets Media.

Eurex Clearing’s just-launched Individual Clearing model enables full legal and operational segregation of all assets (positions and margin collateral) for its non-clearing members (clients with trading admission) at the clearing house level. The new model allows for collateral and positions to be transferred immediately in the event of a clearing member default, thus clients are protected and enabled to continue their trading activities.

The new service is the first segregation solution offered by a clearing house, and Eurex Clearing is the first CCP globally to offer full legal and operational segregation across all cleared markets, the company said.

The Individual Clearing Model responds to the increasing demand of buy-side firms for central counterparty (CCP) services. Through the new service, Eurex Clearing aims to fulfill the planned regulatory requirements as specified in the published draft versions of the European Markets Infrastructure Regulation (EMIR).

Eurex Clearing’s new service will be optional and available for all its listed markets. The next step will be the extension to clients without trading admission and to the future Eurex OTC Clear offering once this has been launched.

By requiring clearing members to offer full segregation to their clients, EMIR may impose higher operating costs by requiring clearing members to ensure that the assets of each client are identifiable at any given point in time on the clearing member’s books, according to a report published by law firm Cadwalader, Wickersham and Taft.

If adopted, the full segregation requirement will make it more difficult for clearing members to use clients’ collateral for re-hypothecation purposes, which has been standard practice for prime brokers and dealers, according to the report.

The CFTC has proposed that each FCM and DCO be required to segregate the cleared swaps of each individual customer and relevant collateral, while permitting FCMs and DCOs to operationally commingle all relevant collateral in one account, known as the legally-separate and operationally-commingled (LSOC) model.

Some DCOs, such as CME Group, contend that the LSOC model proposed by the CFTC will raise operating costs, and recommend instead that the CFTC permit DCOs to use the omnibus model employed in the futures industry, whereby property is treated separately from the property of the FCM, but futures customers are treated as a group, rather than individually.

LCH.Clearnet, however, supports the complete legal segregation (i.e., LSOC) model put forward by the CFTC as the most appropriate model for customers clearing swaps transactions. It’s also the model that most closely parallels the protections that will be required in Europe under the European Commission’s proposed European Markets Infrastructure Regulation (EMIR).

In addition to the complete physical segregation and LSOC models, a third model, known as omnibus, is taken from the futures world. In an omnibus model, property is treated separately from the property of the FCM, but futures customers are treated as a group, rather than individually.

“The best model – offering both protection to the individual without losing efficiency – would be one of legal segregation but operational commingling,” Rogers said. “However, with Eurex leading the PR charge on this, we may see complete segregation as the standard, even if the regulations don’t push it that far.”

The new Eurex service will be offered in addition to the existing Eurex Clearing model. Eurex Clearing will also launch an Omnibus Model, offering segregation of client assets in an omnibus account with higher operational efficiency and flexibility for the clearing member. The three different levels of protection enable clearing members to offer tailor-made access to Eurex Clearing and provide choice for clients.

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