Market structures under no illusions on risk elimination
The securities market infrastructures forum
sessions at this year’s Sibos banking conference in Osaka started on a sobering
note with Global Custodian editor-in-chief Dominic Hobson noting that central
counterparties (CCPs) by their nature concentrate and redistribute risk in the
financial system rather than reduce it.
These “fragile” entities are tasked with
finding additional capital as regulators want them to have “skin in the game”.
While CCPs net transactions against each other, trading large numbers
means greater demands for liquidity, Hobson said.
Hobson said clearing brokers would struggle
to make their margins completely while CCPs would suck the margin of collateral
“CCPs inject liquidity into the system on
the way up and withdraw it precipitately on the way down,” Hobson said, adding
that CCPs are a worrying panic transmission mechanism in the financial system.
Rather than eliminate risk, CCPs concentrate risk and redistribute it to
clearing members, creating a risk hurricane.
Broker-dealers have to find variation
margin, but we are not eliminating the risk of default – we are repackaging
default as liquidity risk, Hobson insisted.
CCPs are going to eat a lot of collateral,
adding to trading costs, he warned, observing that in theory brokers are free
to pile on as much leverage as they can because they know who will ultimately
pay. Multilateral netting at CCPs even helps them to cut the capital cost of
over trading as does anonymous trading – ultimately speculative traders are
going to be drawn to the market.
“We’ve yet to put together an action plan in
the case of a failure of a CCP and a central securities depository (CSD),” said
Opening up the discussion, John Gubert,
chairman of UniCredit’s Global Securities Services executive committee, asked
panelists from the CSD and CCP world to comment on the sustainability of these
market infrastructures and whether they felt the situation was catastrophic,
given Hobson’s comments about risk. Euroclear CEO Tim Howell said certain
aspects of risk could be eliminated. “The more CCP netting, the more efficient
things will be,” he said. “The infrastructures allow you to mitigate risk to
some degree, but saying CCPs are the answer is simplistic. It’s a balancing act
for regulators. It’s a case of helpful competition and risk mitigation.”
Diana Chan, CEO of EuroCCP, agreed that
there is a means to reduce risk through netting. “Bilateral is a riskier
transaction,” said Chan. “CCPs always work through their collateral and they
won’t risk their own capital to take risks. If there is a problem then they
take action to manage a default situation. There needs to be a resolution
regime for CCPs to protect against financial institution failure.”
Sergei Sinkevich, managing director, primary
market and globalisation, Moscow Exchange, said: "The risk-reward ratio is
an issue. How much risk appetite these CCPs have is also important. We need to
look at risk policies for CCPs. Interoperability among these CCPs could help in
Gubert then asked whether the current market
infrastructures are safe or whether defaults were inevitable. Howell replied
that while defaults are inevitable, they do not derail the system. “There will
be a shortage of collateral but regulation would be a good outcome,” he said.
Chan said: “The notion that there is not
enough collateral is not justified. Collateral transformation and more
dispersing of risk not through one provider but maybe several could be a good
Given the concentration of risk through
CCPs, the question of default was explored further. Howell said some
infrastructures could be amalgamators of risk.
The panelists then tackled the matter of
collateral arbitrage, which could have a significant impact on leverage. Hobson
noted that if a party fails to deliver collateral the event becomes systemic.
Howell replied: “There, you would look to
the infrastructure as liquidity sources. But if you’ve got the assets, it’s
second order. It’s difficult to have rules
for collateral arbitrage. There is a cost for mitigating risk, high capital and
Broaching the subject of client failure,
Chan argued that more needs to be done to prepare for that risk in terms of
liquidity. “Trust in the system, intervention from central bank, CSD and
centralisation – it is not all bad and we do have a place where infrastructure
comes together,” she said.
Juggling costs and volumes
The second securities market infrastructure
session addressed the cost of settlement amidst an ever-changing regulatory
landscape, characterised by low transaction volumes and CCP netting.
Against this backdrop, Hobson asked
panelists from the custodian, broker-dealer and infrastructure community for
their thoughts on whether transaction volumes would rise. Robert Scharfe, CEO,
Luxembourg Stock Exchange, gave an upbeat view of the landscape from the Grand
Duchy. “We have 45,000 stocks listed for trading,” he said. Trading volumes may
not come back any time soon, but OTC derivatives on exchange can create more
In contrast, Goran Förs, head of global
transaction services at SEB, described the reduction in volumes as damaging.
“They won’t come back in the future,” he commented.
Christopher Flanagan, co-chief
administrative officer for Asia ex-Japan, Nomura, commented on the region’s
role in sustaining securities business. “For broker-dealers, investment bank
margins are going down,” he said. “Our exchange and custodian customers want
lower commissions. Asia is the bright spot. It will provide customers for us
Costs of fragmentation
Panellists addressed the cost implications
of a lack of harmonisation among market infrastructures. Providing the Asian
perspective, Flanagan remarked that, “Asia has different capital markets in
each location. I’m hopeful that stage-by-stage things will improve and
liquidity will grow with an opportunity for new exchanges.”
In Europe meanwhile, Scharfe saw the role of
exchanges as having changed under MiFID with more competition in terms of
organised trading facilities and multilateral trading facilities. Exchanges,
however, have a pubic institutional role. Instead of cherry-picking they need
to cover the full range of securities.
Reporting by Janet du Chenne, Global Custodian