Call for user-owned utilities to lower central clearing cost

But monopoly or duopoly inefficient, BNY Mellon says

clearing and settlement

Gesa Benda, managing director, collateral management, BNY Mellon Markets Group

The topic of clearing utilities has been discussed in the derivatives industry for more than 20 years. What is most interesting is that the majority of user-owned facilities have either gravitated away from the model or have been taken over by for-profit exchange groups.

Recent examples include the London Stock Exchange Group taking a majority stake in LCH.Clearnet and ICE acquiring Clearing Corp. Regulation and reduced costs appear to be driving these purchases.

Now, particularly for new business lines such as credit default swaps or interest rate swaps, even for-profit organisations have come down on the side of users owning a substantial stake at a minimum in central counterparty clearing houses (CCPs).

We do not believe there is room for a new user-owned CCP. CCPs need to offer portfolio margining between exchange-traded derivatives (ETD) and over-the-counter business. Given the stickiness of ETD open interest, it is unlikely that a newcomer would attract any substantial ETD flow. In addition, the costs of building and maintaining a CCP have increased significantly given regulatory requirements.

Is it possible that a user-owned utility could provide lower costs driven by competition and open markets? Competition among CCPs will drive costs down as for-profit organisations seek to defend their post-trade infrastructure. This applies to CCPs as much as it does to global custodians.

However a large utility, in a monopoly or a duopoly market scenario for example, will arguably not provide for the right incentives to build an efficient CCP model.

Tim Thornton, chief data officer, Mitsubishi UFJ Fund Services

With an increasing range of regulatory reporting requirements the cost of compliance continues to grow. As new rules are added and modified, data mapping from systems to the regulatory reporting templates and subsequently to the file submission format, results in parallel builds for the alternative investment fund managers directive (AIFMD) Annex IV, Dodd-Frank Form PF, the European Market Infrastructure Regulation (Emir), the Foreign Account Tax Compliance Act (Fatca) and others. As to whether a central clearing utility or utilities would be an answer to reducing these costs of compliance, the main driver of the costs is mapping of data from underlying systems – general ledger, investor systems and risk systems – to the regulatory reporting template for each reporting requirement. The costs are in two parts: the initial mapping and build of export/transform tools, and the ongoing maintenance, update and control of the system and process. These costs will be incurred whether data is subsequently submitted to the regulators or to a central clearing utility. However, the primary driver of overall costs is the number of different processes, so if three compliance submissions could be replaced by one, then the costs would decrease significantly. Data could be mapped one time, and one process run.

Could the requirements of multiple compliance mandates be combined? Two candidates would be Form PF and Annex IV – the drivers behind the regulatory developments appear to be the same. However, it has taken years to try to develop a common reporting standard among European regulators for Annex IV, something that is still not in place. To extend a common standard to encompass further and separate submissions such as Form PF seems a long way off and would require a level of global co-operation not yet seen.

Others would be less similar: Emir, for example, has very different data and frequencies of reporting than AIFMD Annex IV, so it would be difficult to see those combined into one utility.

Another issue would be who takes responsibility and liability for some of the more interpretive data points in the filings. While some items are very factual, such as the number of shares of a particular stock, others carry a varying degree of interpretation: for example, risk measures and some derivative exposure calculations. Any central clearing utility would need to handle those aspects, but if it was still the data submitters’ responsibility to perform those calculations, as opposed to submitting the raw data to the utility, then the benefit diminishes, as the work is not really reduced. A utility that is one step removed from the data owner would not, however, be in a position to make a judgement call on such calculations.

An increase in the level of regulatory co-operation and harmonisation would be the most significant factor that would reduce the costs of compliance. These may be across different areas, so a common framework for alternative asset reporting combining Form PF and Annex IV could be established; a common standard for tax compliance combining US Fatca, UK Fatca and the work-in-progress OECD tax reporting standard would also benefit the industry.

Should the industry start moving in that direction then it is possible to see an environment in which central utilities could be of great benefit: receiving one submission and then passing it out to the UK’s Financial Conduct Authority, the US Securities and Exchange Commission and other regulatory bodies, as opposed to reporting similar but slightly different information in a different way to individual regulators.

Jim Bennett, managing director, Sapient Global Markets

Market participants, regulators and exchanges are beginning to recognise the idea of clearing utilities as the answer to reducing the cost of complying with central clearing mandates and improving business profitability. The cost and effort to acquire the architecture to support central clearing is just part of the equation.

What was built today may or not be appropriate tomorrow. Therefore, operations and architectures need to be flexible to change in step with regulations, and the burden of maintaining the architecture to support regulatory change may be too great for many firms.

Regardless of the time, cost and effort that many organisations have spent building their own regulatory systems, many in-house systems are inadequate to meet the demand. The enormous strain of Emir reporting on an organisation today and the advent of other products entering the mandatory clearing space will cause many systems to fail unless significant investments are made on an ongoing basis.

Those institutions that did not initially provide OTC clearing on behalf of their clients are seeking client clearing utilities, although so far, many have underinvested in systems to support the activity. For these firms, the cost of capital and establishing an infrastructure are key challenges, but they have an opportunity to commercialise utilities to manage compliance, risk management, operations and infrastructure, while minimising the cost of clearing.

In a survey conducted by Sapient, buy-side firms, futures commission merchants (FCMs), proprietary high-frequency traders and sell-side firms all indicated potential positive interest of 50% or more in a purpose-built utility to address unique buy-side clearing requirements. Broker-dealers and FCMs may be more receptive to utilities in the future because they address the cost of operations and infrastructure.

Collateral managers, custodians and service providers are responding positively to utility models. In the meantime, industry discussions around margin methodology and collateral management push forward, but what form this will take in the future and the investments required to solve these challenges remains to be seen.

Buy-side firms notably appear keen on designating non-core business operations to industry-wide utilities. In the Sapient survey, 75% of buy-side firms indicated a potential positive interest in utilities. Of the 75%, 10% said they were very interested and 45% said they were interested but need to more fully understand the offering.

  • LinkedIn  
  • Save this article
  • Print this page  

Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.

To access these options, along with all other subscription benefits, please contact [email protected] or view our subscription options here:

You are currently unable to copy this content. Please contact [email protected] to find out more.

You need to sign in to use this feature. If you don’t have a account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here: