Life under EMIR: New clearing houses, new rules, new headaches?
Last autumn, 22 clearing houses in the EU filed documents to get the chance to keep fighting for a piece of the pie that clearing houses will compete for under EMIR. This month, a handful of approvals have come through and more are expected in the coming weeks.
But what will the new clearing regime in Europe mean for service providers and financial firms’ operations? More competition is generally thought of as a good thing, but it’s not always so clear-cut. For a start, it’s not certain how clearing house competition — and potentially later on, consolidation — will materialise. More immediately, industry figures said the biggest impact is likely to be on the amount of collateral needed to trade.
Reemt Seibel, a communications officer at the European Securities Markets Authority (ESMA), said EMIR was designed to encourage more competition in the clearing space. “We are in favour of competition, which is a good thing that helps get prices down and (you) have different choices,” Seibel said.
As EMIR is a post-trade regulation, it encompasses both on- and off-exchange products. But the focus was always on the OTC side as part of the post-crisis regulatory effort to reduce risk and enable authorities to be in a position to identify it.
Seibel said the G20 commitment to build a more a more robust financial system involved creating a more sound post-trade infrastructure.
“Before these new rules, it wasn’t possible because the area was not regulated at all. The entities may well have been regulated, but if you look at the whole EMIR regulation, which includes clearing houses but also trade reporting towards the trade repositories, that will really boost the robustness of OTC derivatives trading,”
Seibel said.
The general consensus is that in the immediate future, houses that tend to clear in certain markets will stick to their traditional patches.
“Basically, the positive thing about the regulation is that OTC is being forced onto exchanges and OTC is being forced into clearing. ISITC Europe believes both those things are a good move given what happened six years ago,”
said Graeme Austin, CEO of ISITC Europe.
“The issue with increasing the number of clearers, which is a concern for our members, is that managing the number of different clearers will become an operational nightmare,”
Austin said.
“Structurally it’s very similar to the idea of moving from one prime broker to multiple prime brokers,” he said. It may be good for a fund manager, but for outsource providers, they have to develop and then look after relationships with every single clearer. Managing collateral across different clearers in an effective manner, an efficient manner, is going to be a headache”.
Andrew Simpson, chief operating officer at Rate Validation Services Pte, also noted that the move to EMIR-authorised clearing houses (under the central clearing requirements for the majority of OTC derivatives) is likely to have an impact on collateral as firms will need to deal with new initial margin and reduced thresholds for variation margin.
“There are various ranges stated about the likely increase in amounts of collateral across the markets that will be needed, be that the BoE study, ISDA or BIS,” Simpson said. “Certainly there’s likely to be an impact.”
But as to whether EMIR will generate genuine competition [in derivatives clearing], he was dubious. ”To a degree, the contracts that are cleared by one clearing house are not necessarily fungible to another and at the moment interoperability has been restricted to money market instruments and transferable securities” he noted.
Larger banks will mainly have systems in place for managing the variation margin, and asset managers will be going through prime brokerages. But industry figures said that by introducing formality to the system, the regularity of variation margin could affect the amount of collateral required in the markets.
Austin added:
“While the idea of improving systemic risk management is a good thing, there will be an increase in operational risk as a result.”
He said he was in no way speaking about any specific clearer.
Orçun Kaya, an economist who specialises in regulatory issues at Deutsche Bank Research, said it’s not clear that multiple clearing firms in the OTC space will emerge to grab market share.
Kaya said LCH Swap Clear on the interest rate swap side and ICE Clear on the CDS side currently had most of the trading volumes.
“There are many new entrants, that’s true, but the question is, what are they going to compete on?” Kaya said. “Because they can’t compete, for instance, on margins, because the margins are stated by the IOSCO CPSS Principles, so many of the points that they can use for competing with each other are basically blocked by the regulatory documents.”
Kaya said one area where firms may compete was better risk management processes.
“So they could argue that, ‘Our clearing house is more safe than the others’,” he said. “But I don’t know how the new entrants will gain market share, because the market is very much concentrated on a fistful of clearing houses at the moment.”
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