Searching for your clearing broker used to be much like
strolling down a long stretch of restaurants in your favourite holiday
destination. Everyone desperately wants you to come in and dine with them,
meaning you weigh each option up carefully before gracing the most appealing
with your business.
Those days are now over for many buy-side firms, thanks to a
new set of regulations targeting the balance sheets of banks. The process has
now become more like trying to gain membership to an exclusive and very
selective club, and even once you have secured that coveted entry you may yet
be kicked back out again in the near future.
Many of the largest brokers and futures commission merchants
(FCMs) – as they are referred to in the US – are now cherry picking their
clients in light of the stringent regulations they now face. It’s not a
decision they are happily making, it is a result of new rules such as the
leverage ratio and other ways global watchdogs are looking at reducing systemic
risk in the banking system.
Even though these regulations target banks, the knock-on
effect on the brokerage finance models has hit the buy-side. The leverage ratio
reduces available balance sheet commitments for client business, making it hard
for them to take on too much risk from clients.
This pressure has forced them to look more precisely at the
fit of each buy-side firm’s risk profile and how it will impact their own
Every buy-side firm is different in this case, depending on
its size and derivatives appetite, but with clearing mandates on the horizon,
many are looking for a clearing broker, whether it be their first, second or
What you need to be looking for
So in light of these wholesale changes and the on-going
window shopping, what do the buy-side need to look for in their provider when
aiming to find the perfect match?
Well to begin with there are some essentials as ensuring
there are robust systems in place, the right business commitment and of course
the price they are charging. Considering the severity of new regulations there
are also many questions around risk and collateral that the buy-side will have
for their potential suitors.
Hannah Meakin, partner in the financial services team at
Norton Rose Fulbright, says that the clearing brokers should also be able to
explain clearly the choice of accounts and the different levels of risk
“We are surprised by the number of asset managers who still
don’t really understand this,” adds Meakin.
“Also they need flexibility and commitment regarding
collateral and commitment, in that the clearing broker will not limit the types
of collateral they will accept or the terms and haircuts on which they will
accept it, at least not without sufficient notice. Some asset managers and
funds may need the ability to post a wider range of assets or a service whereby
the clearing broker can convert whatever assets they have into more liquid
A handful of sell-side institutions – namely BNY Mellon, RBS
and Nomura – have pulled away from offering client clearing, forcing their
clients to begin their search again.
A trend of ‘unboarding’ has also sprung up whereby clients
are being cut-off by their clearing providers. This has made it a concerning
time for medium to small-sized asset managers either maintaining existing
relationships or searching for new ones.
“They [clients] need to know people will be there for them,”
said Jamie Gavin, head of EMEA OTC clearing sales at Societe Generale. “We know
some clients who were with RBS and then moved to BNY Mellon, it is terrible for
them. They want to know if they are going to have to do this for a third time.
“People are now starting to get very nervous that some
clients are getting unboarded and some are getting re-priced and they want to
know that their clearing broker is going to be there for them.
“That is the whole point of clearing right? You are a safe
harbour in a storm for them and if they have concerns that you are not going to
be there for them then that is a worry.”
Gavin believes that with the amount of clearing brokers and
FCMs pulling away from the space, the worst case for the buy-side is having to
start onboarding with another new broker and going through the whole selection
and due diligence process.
One large European asset manager – who preferred not to be
named – said ‘unboarding clients is an issue for smaller asset managers’. The
danger of unboarding and brokers pulling away from the space could affect all
types of buy-side firms according to Gavin.
“It is not just smaller clients getting ‘unboraded’ out it is
larger ones as well, which you wouldn’t expect,” he adds.
“We are seeing institutions who took a while to select their
first clearing broker and go live, now looking to fill their second and third
spots. Finally, we are seeing clients who have not chosen anybody yet.
“It is quite surprising because you would have thought it
would be some of the less sophisticated clients, but we have seen quite a few
large asset managers come forward recently and are only just kicking off their
RFI rounds now. It is quite a mixture.”
The other concern surrounding the termination of the deal
with a clearing broker is the notice period, according to Sebastian Reger,
partner at law firm Sackers.
It will never happen to me
He agrees that the biggest risk is whether the brokers will
continue with client clearing and says that for buy-side firms the termination
period could be as short as a month.
“Clearing members reserve the right to essentially terminate
the services on a relatively short notice,” says Reger.
“The other risk is that clearing members can reduce the
credit line they give you. They reserve the freedom to cut credit lines and
they may make you reduce existing transactions.
“From a buy-side risk point of view, that members can pull
out of the business, or don’t like your credit profile or cut the transactions
they can do for you is a big concern.”
Reger also highlighted that moving clearing broker isn’t
always a straightforward process.
“If you move clearing brokers, we don’t tell our clients
that they can definitely move 100% of their transactions across,” he adds.
Mandatory clearing is set to come into force towards the end
of 2016, meaning the time for buy-side firms to act is now. Though some have
begun clearing early, others are biding their time. The same goes for clearing
broker selection. Many have one clearing broker in place, but that is often not
enough, especially with the uncertainty surrounding the clearing space.
At Norton Rose Fulbright, Meakin represents both buy-side
firms and clearing brokers and says the agreements between the two should pick
up now that there is certainty around the start date.
“Many haven’t started negotiating agreements yet but we hope
they may start to do so more actively now that they can see the first clearing
obligation coming into effect.”
Meakin adds that only the biggest asset managers have begun
clearing at present and the others are still putting arrangements in place.
“Various reasons for this including a desire to get a feel
for what different clearing brokers will accept, such as what terms will really
become market standard, and the need to get so many different internal
stakeholders engaged and to sign off.”
Stefan Schmidt, derivatives trader at Frankfurt-based asset
manager Union Investment, explained that they looked for one local and one
foreign broker among other requirements when making their decision.
“Our criteria was finding two experienced
fixed-income-brokers with extraordinary skills in trading and clearing OTC
derivatives, one local and one foreign,” he explained.
“Since our EMIR project began in 2013 we have started
trading bilateral collateralised and of course we started trading interest rate
swaps centrally cleared. Credit default swaps will follow in the next three
Schmidt added that the decisions were not made in line with
any pre-existing deals with their two clearing brokers, and that the firm
wanted access to clearing houses LCH.Clearnet and Eurex Clearing.
“People are looking for regional experts,” says Steve
Woodyatt, CEO of tech vendor ObjectTrading. “Where there is a regional
specialism there is an advantage.”
Woodyatt added that the services the buy-side receive are
changing. He believes that fees may not have fluctuated much in recent years,
however the services the buy-side receive may be diminishing.
“Fees are not going down or up much, but value is being
removed from the packages so people are getting less for their money,” he says.
“Suddenly some of these sell-side firms don’t offer market data in the package,
The clock is ticking and as mandatory central
clearing for the buy-side draws closer, firms will have to start securing their
clearing broker relationships and that could mean a lot of research and tick
boxes in order to find the perfect match.