CCPs defend direct clearing models for the buy side

FCMs unsure if direct margin posting will deliver capital savings

Phupinder Gill, CME Group: no plans to disintermediate FCMs

Clearing houses are playing down fears that allowing buy-side firms to post margin directly at central counterparties (CCPs) will ultimately lead to the disintermediation of futures commission merchants (FCMs).

"We have zero plans nor desire to disintermediate the FCMs. I am firm about this," said Phupinder Gill, chief executive of CME Group. "Without [the FCMs'] contribution, exchanges and clearing houses would not work as efficiently."

Gill was speaking at the FIA Expo in Chicago earlier today (October 19).

CME is prepping the launch of a new type of clearing membership that would allow derivatives users to post margin directly at the clearing house, instead of relying on an FCM to funnel collateral back and forth.

Eurex Clearing launched a similar service, called ISA Direct, in March.

Clearing houses claim these direct access models will ease the capital burden on CCPs by eliminating the need to hold client margin on their books.

"There is a capital implication with the supplementary leverage ratio and other capital ratios if the cash is kept on the books at the FCMs. If it is not, then it doesn't have an impact," said Gill. "We've been working with the FCMs to create our model and make sure it doesn't impact the desire of the FCMs to want to continue to serve their clients and [at the same time] not carry the capital burden of having those clients on their books."

Jeffrey Tessler, a member of the executive board at Deutsche Börse, said direct clearing was developed for the benefit of FCMs – and that CCPs could help ease the pressure on other capital-intensive businesses, too. "The bigger discussion is taking place at the bank, where the bank is saying to organisations such as Eurex, 'help us'. Part of it is because of new clearing requirements and what that means for FCMs, but the same thing is going on in their securities lending business and their repo business, where the CCP can now play a role as a solution tool for their capital issues," he said.

Eurex has told clearing banks that its ISA Direct service will slash their capital requirements by as much as 80%. Some FCMs remain to be convinced, however.

With every one of those models, the guarantee of an FCM or a bank does not go away. There is still a role for us to play
Christopher Perkins, Citi

Buy-side firms will still need a bank to contribute to the CCP's default fund on their behalf and assume the obligations all members face in the event of a default, which include valuing and bidding on a defaulted firm's cleared portfolio.

"If the FCM is essentially guaranteeing the performance of the direct funding participant, I would argue there is a contingent liability created there, and it will have an impact on the overall capital treatment," said Jerome Kemp, global head of futures, clearing and collateral at Citi. "So I don't think we're completely out of the woods."

Speaking on a separate panel at the FIA Expo, Christopher Perkins, global head of over-the-counter clearing at Citi, also voiced doubts about direct access for buy-side firms.

"With every one of those models, the guarantee of an FCM or a bank does not go away. There is still a role for us to play, and frankly, while we're supportive of these innovations, it comes down to how the FCM is impacted from a capital perspective. How does the balance sheet resonate? You can't just invent these solutions overnight. You need to do vast amounts of due diligence to understand the nature of the guarantee, what's the resulting capital, and can we make returns on this model," he said.

While banks questioned the merits of direct clearing, non-bank market participants at the FIA event expressed support for such initiatives. "A lot of FCMs have so far been very negative to it because I think the view is, 'well, we're not going to get paid for that, so it's not worth it'. And I think that's not the right attitude," said Don Wilson, founder and chief executive at DRW Trading, a proprietary trading firm based in Chicago. "The right attitude should be, 'okay, if I clear your business in that manner, what is the capital impact now on me going to be, and can that capital impact my fixed costs, [and] how would I charge for that'. I think it's a good thing because it opens up another avenue for optimisation."