Rising fees set by clearing brokers have spurred a new model aimed at smaller buy-side firms who are looking for a cost-efficient way to clear their derivatives trades.
The new concept, known as a sub central counterparty (CCP), was inspired by elements from Asia’s clearing market and is now being considered in Europe and the US.
It is one of a number of alternatives to becoming a member of a clearing broker, a process which is increasing in cost due to new regulations, and forcing smaller firms to re-assess their clearing arrangements.
“The problem the buy-side have is that clearing brokers say they are not going to talk to you if you are too small in terms of your clearing requirements,” said Brian Charlick, senior manager, business consulting, trading and risk management, Sapient.
“For 50 trades a year the costs are going to be too small and unless you give them big service they are not going to be hanging around. Some clearing brokers are saying they are going to have minimum charges which could be around £100,000.”
The sub-CCP model was inspired by the situation in some parts of Asia, where trading firms are direct members of clearing houses, along with the Inter-connected Exchange model in India, where trades took place on the platform and were then executed as net positions on other exchanges.
The idea is that buy-side firms would clear through the sub-CCP, which would be a member of an actual clearing house and then clear net positions through the CCP.
Sell-side firms would clear through the actual CCP, leaving the exposure between the sell-side and the CCP. The buy-side could then clear through the sub-CCP at which point the exposure is between the buy side and the sub-CCP.
“This means the CCP and sub-CCP have one sided exposure,” explained Charlick. “So the sub-CCP which, as a member of the CCP, clears net positions through the CCP. The sub-CCP then has exposure between the buy-side and CCP thus netting to zero while the CCP has exposure to the sell-side and sub CCP, netting to zero also.”
The cost of clearing would be reduced due to the basic clearing service and a reduced default fund requirement as the aggregate initial margin of the sub-CCP would be smaller than the major CCP.
The sub-CCP model is still in development but with buy-side firms carefully analysing the price it will pay to clear derivatives, cost-efficiency will play a major part in that decision.
Other options, such as outsourcing and the use of a clearing agent, have also been developed as the sell-side aims to cater for buy-side firms, which have been forced to clear their derivatives transactions due to the systemic overhaul of the markets.