New Markets

Over the last decade the financial services industry has been subject to continuous change, including

  • Dodd Frank & EMIR stipulating higher capital ratios and mandatory clearing of more products
  • Other regulations creating a new capitalised clearing business – Risk; Volker / MiFID II, Balance sheet; Basel III / Leverage Ratio / HQLA , Funding;
  • Onshore capital / Ring-fencing, G-SIFIs
  • Stress Testing becoming critical to business processes and as a consequence forcing the creation of new standards – CFTC 1.73/1.74

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Regulators have increasingly required investors to settle most margined financial instruments via Central Clearing Counterparties (CCPs). Membership in a CCP is not a trivial operational or financial exercise, and many investors have relied on Clearing Brokers (CBs) as intermediaries in the settlement process.  However, many CBs are exiting the business of clearing for third parties, and remaining CBs are increasing costs and reducing the number of clients for which they will clear.  As a result, “orphan” clients (e.g. clients with no clearing relationship) are growing – many of whom are unprepared for establishing a clearing operation and lack the necessary in-house skills.  Only a small minority of CBs  are clearing trades for third parties and of this subset only a handful of CBs are clearing Over The Counter trades (OTC).

Micro regulation, Macro impact

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Financial Markets Changes:
  • Dodd Frank & EMIR
  • Global Systemically Important Financial Institutions (G-SIFIs)
  • Funding – Onshore capital / Ring-fencing
  • Liquidity

 

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Financial Market Impact:
  • Business models now financial resource focused rather than volume driven
  • Compressed bid/offer spreads – trading revenue decline
  • Global Banking to Regional Banking
  • Struggle for Return on Equity (ROE) – Capital destruction
  • Global banks concentrating on reforming business models and Bad Banks
  • Investment for regulatory compliance and infrastructure overhaul

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Financial Market Responses:
  • Reduction in risk appetite & market volatility
  • Market depth impacted – GAP risk increased
  • Market Risk separated from Credit Risk
  • Struggle for derivative certainty/market access
  • OTC standardisation and simplification
Clearing Changes:
  • New capitalised clearing & financing business across:
  • Risk – Volker / MiFID II
  • Balance sheet – Basel III / Leverage Ratio / High Quality Liquid Assets (HQLA)
  • CCP no longer 0% risk weight
  • Stress Testing to new standards – CFTC 1.73/1.74
  • Drive for cash products to be centrally cleared
  • Arbitrage in market pricing – cleared vs. non-clearing
    • Inter CCP’s ie. LCH vs. CME vs. Eurex
  • Uncertainty in market access
Clearing Impact:
  • Significant increase in clearing costs/pricing
  • Post Trade ‘tail risk’ services no longer viable for both clearing & financing
  • Fewer Clearing Brokers / Clearing capacity reduced
  • Risk based pricing, clearing fees – material all-in cost
  • Put option on the derivative portfolio
Clearing Responses:
  • Increase in clearing volumes across OTC, ETD & Repo/Sec Lending
  • Greater Asset segregation & increased membership at CCPs
  • Leverage, Cross Margining & Netting moved to CCPs
  • More regional CCPs
  • Poorly rated clearing brokers
  • More direct memberships, more CCP’s