European market participants should be prepared for significant cost rises across their derivatives businesses following the introduction of the European market infrastructure regulation (EMIR), according to a new report from research consultancy Celent.
According to the report, titled ‘EMIR and OTC derivatives clearing in Europe: Tough times ahead’, the regulation will result in cost hikes for broker-dealers, buy-side firms, central counterparties (CCPs), trade repositories, corporations and regulators.
EMIR was Europe’s response to the Group of 20’s commitment to reduce systemic risk in the derivatives market. The new rules will see OTC derivatives standardised where possible so they can be traded on exchange and centrally cleared. All derivatives trades will also have to be reported to trade repositories.
“The financial implications of the EMIR reforms are expected to be far-reaching,” said Anshuman Jaswal, senior analyst at Celent and author of the report. “EMIR will also drive some significant IT investment in 2012 for market participants.”
As around 68% of interest rate swaps are already centrally cleared, the report clams the biggest impact of the regulation will be on the credit default swaps and FX derivatives markets.
In terms of technology spend, the study estimates that industry-wide costs of compliance will reach US$950 billion, with clearing brokers (21%) and central counterparties (22%) incurring the largest proportion of the total because they will be the main service providers. Buy-side firms are likely to account for around 16% of the predicted technology spend as they improve their derivatives trading infrastructures.
The research also identified portability and segregation as two areas of increased cost for clearing members and buy-side traders.
Portability, which enables firms to move their exposures from one clearing broker to another in the event of a default, could lead to higher initial margin costs.
“Some clearing members may be wary of signing portability agreements if those trades are cleared on CCPs that have high default fund contributions relative to initial margin,” the report noted.
Segregation, i.e. allowing buy-side firms to separate their margin collateral and positions at the clearing house level, could lead to higher administrative and operational costs for the buy-side.
However, the push towards central clearing for OTC derivatives will result in a substantial increase in revenues for providers of clearing and collateral management post-implementation of EMIR to an estimated US$5 billion from US$2 billion currently. This would come at the expense of revenues associated with execution and market making services, which are expected to decline from US$8.5 billion currently to US$6.5 billion, as more derivatives are traded on exchange, according to the report.