Margining and Clearing Pique Interest of Exchanges

Terry Flanagan

With their core listings businesses under pressure, exchanges are hitching their fortunes to post-trade services such as clearing and collateral management.

“There are several different areas where exchanges are focused on technology innovation,” said Steve Woodyatt, chief executive of Object Trading, a provider of direct market access. “Two where I think they see fertile ground are clearing and cross margining.”

“The technologies there are less about traditional technologies and more about product innovation and being able to capture flow that is margin efficient.”

Portfolio margining, which is a general term that includes such methods as single- or one-pot margining, enables clearing members to offset positions in multiple asset classes for the purpose of calculating risk, and is very much in the spirit of the Dodd-Frank Act, which seeks to promote greater transparency into the commodities markets.

Clearing houses LCH.Clearnet and New York Portfolio Clearing (NYPC) have agreed to explore expanding their existing combined one-pot cross-margining arrangement to include interest rate swaps cleared by LCH.Clearnet.

The goal is to deliver greater capital efficiency to market participants by combining NYSE Liffe’s U.S.-traded interest rate futures contracts already cleared by NYPC, fixed income cash and repo trades cleared by Fixed Income Clearing Corporation (FICC) and interest rate swaps cleared by LCH.Clearnet’s SwapClear service into a single portfolio for purposes of margin netting and offsetting.

NYPC allows for one-pot margining of eligible interest rate futures positions cleared by NYPC with U.S. Treasury and agency securities and repurchase agreements cleared by FICC.

CME Group in May began offering portfolio margining of OTC interest rate swap positions and eurodollar and Treasury futures for house accounts.

NYPC, a joint venture between post-trade giant Depository Trust & Clearing Corp (DTCC) and NYSE Euronext, has launched Portfolio Risk Interactive Margin Estimator (Prime), a Value-at-Risk (VaR) calculator that estimates the “one-pot” margin savings clearing members can achieve.

Exchanges are boosting their investments in post-trade processing, both to garner additional revenue and to address the long-term issues of reducing systemic risk embedded in the Dodd-Frank Act, MiFID II, Emir and other legislative and regulatory initiatives.

Nearly all of the major exchanges have their own clearing houses—the so-called “vertical silo” model—where trades made on the exchange are automatically channeled to a bourse’s own clearing house.

The impact of new regulations have put post-trade processing under the microscope.

“Swap dealers and major market players certainly face a considerable compliance burden going forward, and changes across systems, policies and procedures as well as pre- and post-trade work flow are likely warranted,” said Sam Peterson, senior advisor at Chatham Financial, a risk advisor. “This will be a monumental challenge, especially for the Tier 2 and smaller players that may not have the staff or resources available, or systems in place, to adapt easily.”

While cross-exchange connectivity plays a major role in distribution strategy and ease of access, “the real gains would be found in the theme of capital efficiency and the clearing side”, said Woodyatt of Object Trading.

“If I can easily access the SGX [Singapore Exchange] and Eurex via cross-connectivity that’s great,” Woodyatt said. “But if I still have to double up on margin, then it’ll still restrict overall volume. The way it works now is you are still constrained with multiple clearing relationships and multiple sets of margin requirements that need to be funded, lodged and managed.”

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