By Wayne Eagle
Wayne Eagle, Head of Equities, LCH.Clearnet, digs into clearing costs in Asia and unearths the reasons for current clearing structures
Clearing Costs
Clearing is very much a volume business. The infrastructure for a quality clearing operation is expensive to build and maintain, and it is consequently a business in which economies of scale can make a huge difference to pricing. The more the infrastructure can be leveraged, the lower the cost per trade. Conversely, across a region, the more fragmented the infrastructure, the more costly clearing is likely to be.
It is also worth considering the evolution of clearing. In many markets the clearing house is owned by an incumbent exchange, which enjoys a monopoly position. If this entity is a profit maximising institution, it will naturally seek to maximize its returns from clearing and the absence of any competition will mean it has no incentive to lower fees.
Differences between Asia and Europe
The most significant difference between Asia and the Europe is the existence of the European Commission – that is, a body which can legislate across all member countries. It was only the introduction of MIFiD in 2007 that cemented competition in the European markets. The impact of this has been to reduce both the cost of trading and of clearing in many markets and erode the margins of the established players. However, it has also resulted in a more fragmented landscape, and we anticipate that the next evolutionary step will be consolidation.
The situation in Asia is similar in some respects, but different in others. In some markets the established infrastructures still enjoy a privileged position, however, in others, competition is being introduced in the form of alternative trading venues , even without specific legislation, and this is likely to impact costs in the medium term.
Clearing in Asia
There are two reasons why Asia is so important to LCH.Clearnet. On the one hand, Asia is an important part of the global economy and its rate of growth far outstrips the rest of the world. On the other, markets are becoming ever more global in nature and as our clients, many of which are large international banks, grow their presence in Asia they are looking to us to support some of their key trading activities.
Asia has some highly developed and sophisticated markets, however, we believe LCH.Clearnet has unique expertise, particularly in risk management,as was highlighted during the Lehman default.
Pan-Asian Reform
We believe Asian markets will continue to evolve organically. Without a pan-Asian regulatory or legislative body, there is unlikely to be uniform reform across the region. However, the current regulatory approach, which has enabled the development of alternative trading venues in the region, will continue to be supportive of an evolving environment in which competitive pressures are likely to place a downward pressure on fees.
Change through Competition
We believe that all markets are best served by a degree of competition; it is the most effective means of ensuring a quality service combined with competitive pricing. This can be seen in some markets at the trading level, where even the threat of potential competition from new entrants has resulted in lower trading fees.
At the clearing level, a clearing house that is able to consolidate the volumes of more than one market will be able to deliver real economies of scale to the market. We also support any initiative which enhances the robustness of clearing infrastructures and ensures best practice risk management. Lehman’s default illustrated how prudent risk management can ensure that neither a clearing house nor market member need suffer any financial loss, and conversely, how clearing, unless underpinned by robust risk management, does not necessarily protect the market.
As competition is introduced into markets which have historically had protected vertical structures we anticipate seeing some reduction in costs. The extent to which costs are lowered will depend on the degree of competition which the respective regulators permit in each market.
