Push, ping or hub: industry tackles risk of clearing fails
Push, ping or hub
An industry working group is about to publish principles on how to ensure swaps that are subject to a clearing mandate can be guaranteed to clear. But that masks sharp divisions within the industry over which entity should control the process. By Peter Madigan
When a company executes an over-the-counter derivative subject to a clearing mandate, it will face a brand-new risk – that the trade will not complete the journey to a clearing house. If that happens, the transaction would be illegal and, unless a remedy could be found, it would need to be terminated just minutes or hours after it had been executed – which could be costly in fast-moving markets, especially if the trade had already been hedged with another, offsetting transaction.
What the market needs is certainty, at the point of execution, that a trade will clear – and three broad types of solution are being considered. Each tackles the risk that the trade will push one of the entities involved beyond its credit limits, which is seen as the most likely cause of a clearing fail. But settling on just one solution could prove difficult, and some market participants are worried about the potential for confusion.
“If we as an industry don’t come out with a clear view of how the clearing certainty issue should be addressed, dealers, buy-side firms, trading venues and clearing houses will find it very difficult to operate. The alternative is that each participant will build its own systems, and there will be a large degree of fragmentation as everybody conducts their credit limit checks in a slightly different way. That would be the worst possible outcome and it would be bad for the market,” says Paul Hamill, managing director for matched principal trading at UBS in New York.
That is already starting to happen, and it’s not hard to see why. Futures commission merchants (FCMs) provide access to clearing houses for clients that are unable – or unwilling – to join as members, and are on the hook for any losses if a client implodes (Risk October 2010, pages 52–55). As a result, they set limits on the amount of risk they are willing to accept. The same is true of central counterparties (CCPs), which limit the amount of risk an individual FCM can bring into the clearing house. Each new trade will add to or reduce the net total of risk for both a client and its FCM, so the challenge is to find out in advance whether it will breach those limits.
A joint working group set up by the Futures Industry Association (FIA) and the International Swaps and Derivatives Association has grouped the mooted solutions into three categories – the push, ping or hub approach.
Any market structure limiting FCMs’ flexibility to build risk controls could lead to increased systemic or operational risks
Put simply, the push provides a form of clearing guarantee, in which an FCM breaks up its credit limit for each client and parcels it out to the swap execution facilities (Sefs) on which cleared OTC trades have to be executed – that means the Sef knows how much business a firm can transact without needing to check with anyone else. It could make clearing acceptance faster, but might also mean clients have lower overall limits and less flexibility, FCMs warn. The ping involves messaging between Sefs and FCMs, and/or between Sefs and CCPs, retaining flexibility but at the cost of speed – or latency, in the jargon of high-frequency trading. The hub model would work with either push or ping approaches, potentially making them more efficient – but leaving the market at the mercy of a single, central utility that has yet to be built or tested.
With so many actors involved, each of which sees different pros and cons in the various approaches, some dealers are preparing for a market in which a variety of credit-checking processes are available. “I think clients will need to strike a balance between latency and clearing limit size. We are willing to have a flexible approach to accommodate different desires and needs,” says Chris Perkins, global head of OTC clearing at Citi in New York.
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