One of the major pillars of the regulatory
and political response to the financial crisis has been the push to
central counterparty clearing of over-the-counter derivatives.
This policy, on which authorities around the world have developed a high-level
consensus (although with differences of detail), has a number of different objectives:
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To increase transparency of positions and exposures to regulators and potentially, in a sanitised form, to the general public;
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To mitigate the credit exposure of buy-side clients to their clearing brokers.
On the third item, a key point is that traditional CCP clearing as it
evolved in the listed derivatives markets does not necessarily protect a
client against their clearer’s insolvency. The extent to which it does
this at all is a function of the rules of the clearing house, its
jurisdiction, and the jurisdiction of the clearing member amongst other
factors - the variance between different offerings and the degree of
legal complexity can be considerable.
From an early stage in the development of post-crisis policy around
CCP clearing in OTC markets it has been clear that closing this gap is
on the to-do list and there has been a great deal of work to develop
approaches to this. Significant examples are the client clearing
extension to LCH. Clearnet’s established SwapClear service for IRS and
also the ICE Trust and CME offerings for CDS products.
The pace of this work, leapfrogging stages of development that might
have taken years, has been very rapid. However large scale uptake has
not yet begun, and actually incorporating new structures and workflows
into the business models of buy-side participants will require sustained
effort. Navigating this transition period
will be a challenge for
asset managers and other buy-side participants, as there is still a
level of uncertainty about how this process will play out, but some
observations can be made:
-
It seems likely that, with the possible exception of
non-financial end users, buy-side participants will be obliged by
regulators to move progressively into OTC clearing, and other distinct
but related infrastructure linkages (e.g. use of trade repositories)
-
There are very real advantages to OTC clearing for the
buy-side: most obviously dramatically reduced counterparty risk but also
operational risk reduction and transparency. However it is unlikely
that these benefits will positively and discernibly impact the bottom
line in the near term.
-
There are also real costs, and these will come through more
quickly and visibly than the benefits – costs of implementation work and
increased operational establishment will be felt immediately and it is
likely that increased commitments of collateral and possibly additional
cost in fees will follow
-
Despite rapid progress, the end-to-end process specifics of
how buy-side clearing will work are not yet fully developed or
consistent across the major OTC asset classes.
Given these points, the decision for asset managers is fairly clear:
do I want to be a trailblazer, or run with the pack? And what would be
the costs to being a straggler?
Which of these is the best option will vary for different players;
for example pension funds, traditional asset managers, large hedge funds
and small hedge funds should all emphasise different criteria. But with
a clear movement towards change, the ‘ostrich strategy’ however would
probably be a poor one!
Rollo Burgess is a capital markets expert, PA Consulting Group.
If you would like to contact Rollo by email, please click here.
To visit PA's page on capital markets, please click here.
To visit PA's page on financial services, please click here.
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