How will forthcoming clearing regulations spur competition in Europe?
New regulations will dramatically change the clearing landscape across Europe. The MiFID II requires central counterparties (CCPs) to clear derivatives trades for any venue across the continent, known as the open access rule. The overhaul is in line with increasing transparency and competition within the derivatives market.
The major point of contention arises within this requirement, as many of Europe’s largest CCPs are owned by stock exchanges, which could be forced to provide clearing for competing venues. Major players such as Eurex, CME and Intercontinental Exchange operate a vertical silo, in which contracts are traded and cleared at the same exchange. The new regulations pose a huge threat to that model through open access and opens the playing field up to new venues in the market.
Will the regulatory changes actually achieve the intended goals of making the markets safer, increasing competition and driving innovation?
This is still being debated to this day. On the one side, the exchange-operated CCPs argue that the regulations are a blatant attempt to break up their vertical models and would discourage investment, infringe on intellectual property and put them at a competitive disadvantage with their US counterparts. On the other hand, new exchanges competing with the incumbents, along with horizontal models such as LCH.Clearnet, welcome the decision claiming it will drive innovation and open up competition in the market, providing investors additional savings.
Another worry from regulators is that risk has been transferred onto the clearing houses. The effect of a CCP defaulting would be disastrous as all OTC products now move toward clearing, with new collateral rules coming into force. Interoperability among CCPs would mean that if an exchange or clearing house went bankrupt, the choice of clearers would allow another CCP to fill the void.
What are the benefits of opening up the market and increasing competition?
The changes have allowed room for margin offsets and collateral efficiencies. The likes of CME and Eurex are looking to build out their OTC businesses alongside their exchange-traded operations and offer cross margining efficiencies. For example, Eurex has applied this methodology to its interest rate products where cross margining concerns the allocation of positions of listed fixed income products and OTC interest rate swaps products in the same liquidation group. The reduced risk then leads to lower initial margin requirements. There could also be room for cross-exchange futures consolidation into a single CCP where offsets can be made with similar products. Again using the example of interest rate products, this time there could be significant margin offsets between Eurex’s long-term futures and Liffe’s short-term contracts. The vertical silos could also begin charging a single execution and clearing combined fee, which could discourage participants to clear elsewhere. Whatever form the end rules take, CCPs and exchanges will be scrambling to offer lower costs to secure market share in the new landscape.
The rules could also see the emergence of smaller competitors in the markets with the likes of Nasdaq OMX NLX, which was set up in direct competition with the interest rate incumbents last years, benefiting from open access. Additionally, if NLX could cross-margin against LCH.Clearnet’s OTC positions then it could be in line to attract more futures participants away from the major players, which currently dominate the market.