More Diverse Participants Should Use Central Clearing

Shanny Basar

Clearing houses should offer opportunities for netting offsets to increase the number of over-the-counter participants in central clearing and improve market quality according to Joanna Cound, head of global public policy, Europe, Middle East and Africa at BlackRock.

Cound is also a board member of the Asset Management and Investors Council, which represents the buy side, in the International Capital Market Association. She wrote an article on central clearing in the AMIC annual review and reiterated that BlackRock is supportive of central clearing.

Joanna Cound, BlackRock

Joanna Cound, BlackRock

She said in the review: “The reduction in bilateral counterparty credit risk, increased market transparency, together with the improved efficiency in trade execution outweigh the significant operational costs incurred by market participants and end- investors to comply with clearing mandates.”

However, she also warned that the current market structure was not fully designed to handle the diverse set of clients or the range of market risks inherent in over-the-counter products. Cound continued that regulators and the industry should try to bring a greater number of OTC participants into clearing and to evolve clearing models.

“While central clearing of OTC derivatives as a concept and market practice matures, the framework to incentivise clearing through resilient CCPs, that protect the interests of all stakeholders in times of stress, is still a work in progress,” she added. “Indeed, the recent losses incurred in the Nordic power markets revealed that CCPs are not immune to market disruptions.”

In September there was a default at Nasdaq Clearing in the power market when a Norwegian trader, who cleared his own trades, could not meet the required margin calls and was declared in default.

Clarus Financial Technology, the derivatives analytics provider, said in a blog Nasdaq had a total default fund of €166m ($188m) and cost of closing the relevant positions was €114m. This cost was covered by clearing member contributions of €107m and €7m from Nasdaq. The CCP then asked members for €100m to replenish the default fund.

Amir Khwaja, Clarus Financial Technology

Amir Khwaja, Clarus Financial Technology

Amir Khwaja, chief executive of Clarus, said in the blog: “Of course those who lost a large chunk of their contributions will ask why the initial margin and default fund contribution of the defaulting party was not sufficient to cover the loss. But that can be a double-edged sword, as most members would not want initial margin to be so high as to never require the use of a default fund, that would make clearing more expensive for all.”

Cound added: “The importance of continued regulatory focus was emphasized by the large mutualised loss experienced in the Nordic power markets earlier this year, with two-thirds of a CCP’s default fund consumed by one single clearing member default. While the CCP proved resilient, the loss allocation defied expectations and should challenge assumptions.”

To protect the end-investor from bearing losses due to the failure of CCPs, Cound said Blackrock objected to the use of variation margin gains haircutting and requested that regulators formally limit its application.

She continued that having more participants using central clearing improves market quality as there is more liquidity when trading in and out of a position. To increase the number of OTC participants in central clearing and to evolve the clearing models Blackrock recommends that CCPs should offer opportunities for netting offsets.

“These could incentivise clients to clear more positions voluntarily through the CCP,” added Cound. “Such offerings should be carefully constructed and regulated to avoid a race to the bottom in risk management.”

Pension funds should also be able to post securities as variation margin to the CCP and market participants should improve co-ordination and address inconsistencies.

“Private sector stakeholders should better co-ordinate participation across end- users, clearing members and CCPs when launching new product,” said Cound. “Also, addressing inconsistencies around the costs of clearing (which ultimately are borne directly or indirectly by the end-investor) could help to facilitate broader participation.”

She continued that policy makers should renew their focus on cross border equivalency for CCPs and consider granting equivalency for clearing members.

“A view on regulatory equivalency between CCPs and clearing members is required,” she said. “Various jurisdictional requirements that restrict access to extraterritorial CCPs or clearing members impede the ability for end-users to efficiently access clearing services.”

For example, the European Union has proposed that systematically important clearing houses that clear euro derivatives have to be located in the EU after the departure of the UK. In addition Eurex Clearing, the clearing house owned by Deutsche Börse, launched a partnership program last year to build a liquid alternative for processing euro denominated interest rate derivatives in the remaining EU27.

SwapClear record

LCH, the clearing house owned by the London Stock Exchange, said in an email today that it had cleared more than $1 quadrillion in notional in interest rate swaps in the first 11 months of this year. By the close of business on 30 November, SwapClear’s cleared notional reached $1,001 trillion.

Cameron Goh, global head of product, rates, at LCH said at a media briefing last week that LCH has not seen any reduction in swap clearing volumes despite the Brexit uncertainty.

Cameron Goh, SwapClear

Cameron Goh, LCH

He said at the briefing: “We are on track to have another record year with volumes up 26% on last year. Euro swap clearing volume has significantly grown and a record number of eurozone domiciled counterparties have joined LCH this year, including eurozone located pension funds who want to clear at LCH.”

This month the European Securities and Markets Authority said it wants to introduce a limited exemption to facilitate the novation of certain non-centrally cleared OTC derivative contracts to EU counterparties  if the UK leaves the EU without the conclusion of a withdrawal agreement – a no deal scenario.


LCH added that SwapClear has compressed approximately $700 trillion in swaps in the same time period. Compression allows clients to reduce the notional and trade count in their portfolios and increase capital efficiency through “tearing up” offsetting trades while maintaining the same risk profile.

Last week CME Group also completed its second successful compression cycle of 1.3 million S&P 500 and E-mini S&P 500 options on futures contract sides, more than doubling the number of contracts in the first compression run in October. The US exchange said in an email that five market makers and two clearing firms participated in the second compression run on November 26.

CME Group said it has compressed nearly 1.9 million equity options contract sides for market participants, reducing portfolio size by an average of more than 20% in these two compression runs.

In October CME Group also took part in its first initial margin optimisation cycles for non-deliverable forwards with Quantile Technologies. NDFs are derivatives that are used to hedge or speculate against currencies where exchange controls make it difficult for overseas investors to make a physical cash settlement, for example, the Chinese renminbi.

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