With the amount of collateral held by central counterparties (CCPs) expected to rise to as much as to US$2 trillion as over-the-counter (OTC) derivatives move onto CCP platforms, market participants must understand their role more deeply, a new report suggests.
A report by research firm Finadium looks in detail at the CCPs, which have emerged as critical players in the financial markets after regulators made it clear that OTC derivatives should move from the bilateral world to central clearing platforms.
CCPs are a heterogeneous group of organisations worldwide with diverse ownership and do not conform well to the desires of regulators seeking to impose one framework for operations and risk management, according to Finadium. Currently CCPs control at least USD 400 billion in collateral assets as per data collected from annual reports of CCPs recently.
The Finadium report, which serves as a benchmark guide for understanding CCP rules and roles, says CCPS are currently working to harmonise the demands of regulators that are emphasising the safety of CCPs with the realities of managing risk across a variety of product types and a diversity of users.
Compared to bilateral clearing which is predominantly manual, CCPs are highly automated and can manage vastly more collateral substitutions. They also have the ability to conduct intraday collateral calls on a frequent basis. Regulators see the processing strength of CCPs as an important cornerstone for operational risk management, hence heir desire for all standardised OTC derivatives to be cleared on CCPs in the coming years.
The CCP landscape will evolve based on strategies around three main areas: OTC derivatives moving to the futures market; consolidation in the CCP industry; and clarity over which products are appropriate for CCP clearing. Several CCPs have expressed their preference that OTC derivatives should ultimately be part of the futures market to reduce margin obligations and protect clients from additional regulatory requirements, particularly under US Dodd-Frank Act. The report also says CCPs are not ready for cross-border margining or even cross-product margining until regulators sort out global bankruptcy laws. However, CCPs are not against consolidation of ownership, which will allow a reduction of investment in technology and headcount and prove cost-effective for end-users.
Another new report by Berenberg Bank says that European CCPs could experience a capital shortfall of EUR 750 million after the implementation of European market infrastructure regulation on clearing house capital requirements. The largest driver of the capital shortfall is the requirement that CCPs hold capital linked to the size of their cost bases. Given clearing it is largely a fixed cost business, the capital raise is largely a one-off, and capital levels need not scale with any potential growth in clearing activity. The report says that the impact of the regulation on CCPs could vary. It identifies LCH.Clearnet as that one that could be highly affected and ICE Clear Europe and Eurex as modestly affected by the capital shortfall.