Buy-side unprepared for OTC central clearing
Pension funds and asset managers are nowhere near ready for
the central clearing of OTC derivatives, delegates were told on the final day
of the Sibos 2012 banking conference held in Osaka last week.
Stemming from the Group of 20’s 2009 Pittsburgh summit, new
swaps rules, including the Dodd-Frank Act in the US, will push a greater portion
of the OTC derivatives market through central counterparties (CCPs) with the
aim of reducing systemic risk and increasing transparency.
William Filonuk, managing director, global research and
development – capital markets at the asset servicing arm of BNY Mellon, said in
the face of overwhelming regulation and slipping mandates, the buy-side is not
yet ready to implement the clearing of OTC derivatives on CCPs.
“The advantages of central clearing are slightly less clear
for the buy-side than they are the sell-side,” added Paul Swann, president and
chief operating officer of ICE Clear Europe, which clears credit default swaps
for European clients of US-owned InterContinental Exchange. “The benefits for
the buy-side are standardised collateral and standardised documentation but
this isn’t as obvious as, for instance, multilateral netting for the
But while CCPs are furiously preparing for central clearing
of the most liquid OTC derivatives, Swann asserted that the challenge is not an
infrastructure problem: “They’re ready for client clearing. The problem is
getting the rest of the industry ready when many of the required regulations
aren’t even ready yet.”
Takeshi Hirano, director of OTC Derivatives Clearing Services
at the Japan Securities Clearing Corporation, said the buy-side in Japan needed
more time to prepare for clearing, adding on the day of the panel session – 1
November – Japan became the first country to adhere to the new G-20 mandate by
beginning the compulsory clearing of interest rate swaps.
“CCPs need to establish the best way to protect the client,
otherwise they will not make it clear enough to the buy-side why central
clearing is important,” said Hirano.
The G-20 requirement for previously bilateral derivatives
contracts to be cleared centrally has led to speculation over how many CCPs the
industry will eventually need. Some have predicted and dramatic increase in the
amount of providers while others forecast a contraction.
“In the short term, we will see more CCPs than are
desirable,” said Filonuk. “But medium to long term we are likely to see a
The more concentrated the better, was the opinion of Swann,
however admitting one CCP per asset class was “probably not the best solution”.
“How many is the right number will depend on how they serve
the market,” he said.
Hirano warned that one CCP per asset class would amount to
overly concentrated risk, but emphasised that quality of service should be the
primary concern of market participants.
Highlighting industry fears over collateral arbitrage, i.e.
the possibility that CCPs might allow lower forms of collateral to win
business, Swann said ICE was not interested in any race to the bottom.
“We are highly incentivised to make sure we have a safe
model,” said Swann.
Global standards or benchmarks will prevent any “race to the
bottom”, believed Hirano.
Yet, the move to central clearing also means the industry
will lose certain risk management strategies which have hitherto been open to
market participants, argued Craig Pirrong, professor of finance, Bauer College
of Business at the University of Houston.
“The move to CCPs is breaking up participants’ ability to
use netting,” he said. “But you need to look at the systemic risk as a whole.
Netting reallocates risk but it does not reduce it.”
A number of regulators from major G-20 countries have
written to US watchdogs over the implications of the Dodd-Frank rules for
markets beyond the US, while some Asian market participants are believed to be
considering withdrawing from conducting OTC derivatives business with US
counterparts to avoid becoming subject to US regulatory scrutiny.
Pirrong warned that extraterritoriality issues could lead to
a fragmentation of derivatives markets along jurisdictional lines: “There’s a
real danger that if participants are not happy with the terms of certain
jurisdictions, they will simply say ‘we’re not going to play in your sandbox’.
This will eventually lead to less choice of market participants and
unanticipated risk,” he said.