SHAKEN NOT STIRRED.
The lines are being redrawn on the clearing and settlement map. Mary Bogan reports.
The sleepy world of post-trade services is facing a roots and branches shake-up. As new regulations, in the US and Europe, work their way onto the statute books, creating some hugely lucrative opportunities for some players and threatening the very survival of many more, competition in the clearing and settlement space has never looked so intense nor the future so unsure.
“The complexity of the regulations, and the magnitude of potential change that impacts the entire global landscape generally, mean financial institutions are moving into uncharted water. There are few certainties about who will emerge as market winners,” says Saheed Awan, head of global collateral services, Euroclear.
Squeezed in between a regulatory agenda focused on stoking up competition while reducing risk, and a voracious client appetite for products that optimise capital and asset holdings but at no extra cost, the post-trade institutions are having to think fast as the ground shifts beneath their feet.
In the clearing market, the decision by global regulators to drive OTC derivatives trade onto exchanges presents one of the biggest opportunities and threats to incumbent players. “With a new flow worth over $700 trillion, there’s a huge historic business opportunity here for clearers,” says Javier Tordable, CEO of technology provider Cinnober. “Not every incumbent clearer will be able to adapt their business model to cope with OTC complexities and some will stay focused on core business so I’m sure we’ll see new clearing houses enter the OTC business.” Recent announcements by NYSE Euronext and CME of plans to build new clearing facilities for derivatives in Europe are a sign more newcomers into the clearing space are on the way, says Tordable.
However, growing competition in the clearing space is also being powered by another force. As regulations governing capital and liquidity requirements grow more stringent, so the clamour from banks, demanding interoperability between CCPs, gets louder. Interoperability between CCPs, say advocates, cuts inefficiency and risk by allowing market participants to net and consolidate trades into one single obligation using one pot of margin and one set of procedures in a relationship with just one preferred CCP. It also exerts downward pressure on clearing fees by injecting greater competition between CCPs.
Earlier this year, interoperability seemed to be an unstoppable market force after several trading venues, led by BATS Chi-X, opened the doors to four-way interoperability. In addition, the decision by EC regulators to block a mega-merger between NYSE Euronext and Deutsche Borse seemed to take the steam out of “vertical exchanges”, which restrict choice by forcing customers to drive trades through the exchange’s own CCP.
“I’m not expecting the floodgates to interoperability to open soon”, says Hugh Brown, director of UK markets at EMCF. “EMIR blesses interoperability but it doesn’t make it mandatory.” According to Tordable at Cinnober though, the pressure from market participants, gunning to consolidate their trade flows into just a handful of large, strong CCPs, will inevitably lead to more competition and consolidation. “We’re already seeing it with deals such as LSE’s recent acquisition of LCH.Clearnet.”
Rising competition though among CCPs has fired up safety concerns in some quarters. “What the advent of OTC derivatives into clearing does is to migrate bilateral risk between market participants to the CCP. Is that risk going to be managed appropriately and will CCPs create additional systemic risk which could impact on other on-exchange business categories”, asks Ian Cornwall, head of market structure at SIX Swiss Exchange.
Concern also centres around pricing and fair competition. Urs Wieland, CEO, SIX x-clear, has publicly argued that prices are currently as low as they can go. Offers of capped fees at certain trade levels suggest clearing has become a subsidised, loss-making activity for some CCPs, he says, and compromises the notion of a level playing field.
Brown at EMCF agrees. “I share the concern that some CCPs, who do not have to make a return, are pricing unrealistically to generate new business”, he says. But regulatory moves to create common standards for CCPs, he argues, should curb any risk of competition moving into risk management or CCPs marketing themselves on the basis of reduced margins.
To remove the temptation to compete on margin and to strengthen risk management, says Robert Barnes, CEO of UBS MTF, what CCPs need is some “skin in the game” and is calling for CCPs to be required to put their own resources into the default waterfall as a curb on reckless behaviour.
For larger CSDs especially, the burgeoning demand from both market participants and CCPs for capital and collateral management and optimisation, is proving welcome news. Even more than clearers, CSDs are on the cusp of a brave new world. Apart from the EC’s proposal to separate out banking services from the larger CSD’s settlement services, T2S, an initiative driven by the ECB, promises to break down protected national barriers and create open access to Europe’s settlement markets. That has clear implications for pricing. “The natural outcome of T2S is that settlement becomes commoditised so CSDs will need to move up the value chain and offer more value-added services,” says Hersh Tegala, head of business intelligence at Clearsteam. “We want to ensure we still attract a critical mass of securities onto our books and continue to provide best-in-class asset servicing with collateral management – a major industry concern at present, as our differentiator.”
At Euroclear too, collateral management and optimisation is regarded as the space where CSDs, with large pools of collateral, can add value. “Collateral management is the paramount weapon for risk reduction and regulatory capital efficiency,” says Awan. “It’s the one of the most important responsibilities today in managing your clients’ assets in an optimal way.”
With many institutions facing a tsunami of regulations, Awan says there’ll also be opportunities for CSDs with the scale and resources of Euroclear to collaborate with other CSDs, CCPs and other market participants. Last November, Euroclear France introduced collateral management services with the central bank of France and Euroclear Bank now has cross-border collateral management arrangements with the Hong Kong Monetary Authority. In July, it launched the “Collateral Highway” which aims to source securities to be used as collateral by providing the infrastructure to move securities where and when needed, no matter where the collateral is held. “It’s a just-in-time approach to collateral management,” says Awan.
BNP Paribas has signed up as the first agent bank to work with Euroclear on the Collateral Highway – another example of how partnership and collaboration between previously competing institutions is likely to characterise the new post-trade space. “We think we will see partnerships that you wouldn’t have believed possible four or five years ago,” says Awan.
For smaller CSDs, with expertise in the legal and tax structures of its local jurisdiction, survival may be probable short-term. Long-term though, they will have to meet the challenges of cross-border competition head-on, following the example of bolder national CSDs such as VP Securities in Denmark.
A small organisation (160 people), which left behind its non-profit status in 2000, it runs a large-scale operation offering highly competitive prices on yearly clearing and settlement volumes of around US$5 trillion. According to CEO, Johannes Luef, over a third of revenues now come from non-traditional CSD activities, such as issuer serving and consulting, and, in 2007, it opened a new CSD in Luxembourg to make it less costly for Danish banks and mortgage companies to finance operations in the Eurozone. To prepare for increased competition and T2S, VP is currently investing in a sizeable overhaul of its systems, backed by its shareholders, Denmark’s major financial institutions.
“I think technology will be key”, says Luef. “One of the basic principles we have agreed with the market is, yes, of course we should join T2S but in such a way that VP takes the load. That’s deep in the architecture of the change and has eliminated customers’ fears.”
It’s a new game in post-trade services and new CCPs and new-look CSDs are on their way. “We’re seeing market participants at different levels looking up and down the value chain for new opportunities,” says Nathan Renyard of BAT Chi-X. “There’ll be a blurring of roles in future and the role of custodians and CSDs will be harder to define.”
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