The Next Battleground: Post-Trade Services
Clearing and settlement, once considered backwaters, have come to be regarded as the crown jewels of an exchange’s portfolio.
Clearing and settlement, which are all but invisible to retail investors, are the backbone of financial markets, upon which the integrity of the system rests.
Weaknesses in the post-trade infrastructure can leave the entire global economy vulnerable to the shocks that leveled Lehman Brothers and brought on the 2008 financial crisis.
As a result, 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 acquisition by the London Stock Exchange Group of a majority stake in LCH.Clearnet in April is intended to bolster LCH’s ability to compete for both listed and OTC clearing services, while preserving LCH.Clearnet’s horizontal model.
LSE has also committed to LCH.Clearnet’s principles of an open access, horizontal multi-asset class and multi-venue clearing model.
“Post-trade services are a core part of our business, and with more regulation focused on clearing, particularly shifting over-the-counter derivatives through CCPs [central counterparties], it is only going to become more important,” said Nigel Harold, head of business development, technology, at the London Stock Exchange.
“Post-trade is a cornerstone of risk management and the current macro-environment has pushed this to the top of the agenda.”
Clearing and other post-trade services have increasingly become core businesses for exchanges, as the takeover bid by Hong Kong Exchanges and Clearing (HKEx) of London Metals Exchange (LME) makes clear.
“LME is a great example of this, since HKEx reportedly bought the company based on the potential to set up a clearing business,” said Patrick Lastennet, director of marketing and business development, financial services, at Interxion. “Other examples include LSE buying LCH Clearnet, and NYSE Euronext setting up an in-house clearing house.”
Post-Trade As a Business
Exchanges are ramping up their entire range of securities processing—from market data to order management to risk management, all the way through to trading, clearing, settlement and other record keeping functions.
Bombay Stock Exchange’s (BSE) increase of its stake in Central Depository Services (India) (now 54%) is a reflection of how the Indian exchange views various new post-trade businesses.
“In India, clearing fees are embedded in the trading fee,” said BSE spokesperson Ketan Mehta. “BSE has significantly changed its collateral management and clearing/settlement systems to make them state-of-the-art.”
As the universe of cleared products expands, post-trade service providers are providing clients with a single point of connectivity to transact with multiple counterparties and to direct trades to multiple CCPs and trade repositories.
“Clearing and post-trade services will continue to get closer to real-time,” according to one exchange executive. “What you will start to see over the next several years is everything will begin to shorten in cycles with regards to clearing processes and post trade risk— all of those components will move closer to real-time. You’ll see more processes headed toward straight-through processing and more of a real-time architecture.”
MarkitSERV, for example, an electronic trade processing service for OTC derivative transactions, has launched connectivity and workflow tools in support of LCH.Clearnet’s expanded service for SwapClear, its interest rate derivatives clearing service.
The workflow functionality will benefit U.S. clients subject to the Dodd-Frank Act. MarkitSERV enables asset managers to select multiple futures commission merchants (FCMs) on a single block trade, have block trades cleared by SwapClear on a split-by-split basis, and “anonymize” sub-accounts and FCMs on any given trade.
Executing brokers can use MarkitSERV to designate their own clearing member for trades cleared through SwapClear.
In 2011, State Street expanded its futures commission merchant services to cover swap clearing capabilities. The derivatives clearing offering combines the expertise of eExchange, a division of State Street Global Markets and State Street Global Services.
A pitched battle is being waged in Europe over the scope of legislation on post-trade infrastructure, in particular over the issue of non-discriminatory or open access to clearing venues.
In June, a senior European Union lawmaker criticized attempts by some in the industry to lobby against European Commission proposals in MiFID II to put an end to the ‘vertical silo’ approach, which many of the region’s incumbent exchanges currently operate under.
“[There must be] open and fair access to trading venues and central counterparties,” said Sharon Bowles, a Liberal Democrat MEP, who is the first Briton to chair the parliament’s influential Economic and Monetary Affairs Committee.
Last October, the European Commission, in its updated MiFID II proposals, announced plans to introduce a more horizontal approach—allowing “open access” to competitors’ exchanges—whereby clearing structures would be able to centrally clear products for various exchanges and execution facilities.
Examples of vertical silos for futures and derivatives include InterContinental Exchange through ICE Clear Europe, CME Group with CME Clearing Europe and Deutsche Börse with Eurex Clearing, as well as various national clearing houses for the equities markets.
Horizontal clearing structures, which encourage market competition and supports new market entrants, include LCH.Clearnet, SIX x-clear, the Options Clearing Corporation and the Depository Trust & Clearing Corporation in the U.S.
In Brazil, regulators are weighing up whether to require the incumbent exchange, BM&FBovespa, to provide overseas competitors with access to its post-trade clearing services.
The Comissão de Valores Mobiliários, the securities market regulatory body in Brazil, last month published a study by European consulting firm Oxera on the costs and benefits of changing the competitive structure of the market for trading and post-trading services in Brazil.
The Oxera study concluded that BM&FBovespa would be likely to continue as the monopoly provider of services in Brazil, because entry by either a trading platform on its own or a trading platform with a linked central counterparty would be difficult, if not impossible, without the co-operation of Companhia Brasileira de Liquidação e Custódia, the Brazilian clearing house owned by BM&FBovespa.
The repercussions from the financial crisis have led to the G20 reforms, which provide that steps be taken to identify and protect systemically-important financial market utilities such as CCPs.
“As exchanges move back to more of a vertically-integrated business [model], including clearing, this increases their technology requirements and, in some instances, puts even more pressure on having the most optimal business continuity or disaster recovery plans in place,” said Interxion’s Lastennet.
In the U.S., for example, financial market utilities that handle post-trade processes will become to regulatory scrutiny under a rule adopted by the Financial Stability Oversight Council.
IRS trading volumes have fragmented without an equivalence agreement.
Phase 5 of the uncleared margin rules came into effect on 1 September.
Triparty repos can be executed across U.S. Treasury securities to central clearing.
CEDX opened on 6 September, offering contracts on Cboe Europe single country and pan-European indices.
A significant proportion of total collateral held with CCPs globally can be automatically optimized.