Changing your clearing broker is a little like changing your custodian, says Luke Brereton, co-head of Eclipse, Standard Chartered’s new clearing service: it is something that you are going to look at every five years or so and the process is so involved that there better be an extremely good case for making that switch.
Given this proclivity for derivatives traders to stick with the clearing platform that they are most familiar with, it was a bold decision that Standard Chartered took three years ago to roll out its own clearing service. Now in its fourth year of business, the hard work involved in bringing Eclipse – which stands for Execution, Clearing, Liquidity and Portfolio Services – to market is starting to pay off.
“We are really focused on Asian markets and being a clearing broker in these markets is not just a volume game,” says Brereton “With 80–90% of cleared trades going through western clearing houses, we have to make sure that clients that use G20 swaps have access to these clearing houses. At the same time we have to make sure that we don’t separate cleared trades with products that are not part of the clearing set – otherwise we would bifurcate the risk in the portfolio.”
This was the rationale behind Standard Chartered adopting a cross-service margining approach, providing clearing services for cross-currency swap and local market interest rate swaps, as well as G10 interest rate swaps.
“In this way, we can bring together a client’s portfolio, which is often quite delta neutral or at least well hedged, to bring them more efficiency,” says Brereton. “If we came to our client base with only clearing, this would not be helpful to them, but the fact that we can actually be the custodian of more of their derivative portfolio across forex and rates is really beneficial to them.”
Having settled on a niche clearing proposition that was not reliant on a high-volume strategy in order to drive growth, Standard Chartered had to make sure that it developed a sustainable business model that could make the Eclipse service pay for itself.
“We recognised from the outset that Eclipse wasn’t going to be a large-volume business because of where our client base is and who we are trying to support, so we need to be clear on exactly how much capital a client’s portfolio consumes on a monthly basis and explicitly pass this cost back to the clients that we clear for,” says Brereton. “This helps us be a self-sustaining business and gives the clients real clarity on what the cost of clearing is for them. It also encourages clients to keep a tidy portfolio from a capital perspective.”
Such a business model is a departure from the traditional world of client clearing, where fees are often set at a fixed number of basis points on top of the initial margin. For cash, this might be in the order of 20bp, whilst for securities it would probably be under 10bp, says Brereton.
“This is just to cover a certain percentage return on the RWA [risk-weighted assets] that you have with the CCP [central counterparty], but what dominates the capital situation is not the RWA but the leverage ratio, the backstop measure of risk,” says Brereton. “We want to calculate exactly what the capital usage is and pass that charge back to the client.”
Relying on a flat basis-point charge that was calculated according to the initial margin would not have been accurate enough, says Brereton; depending on the client’s portfolio and market conditions, the bank would run the risk of either completely overcharging or completely undercharging clients.
Clients really appreciate the transparency embedded in Eclipse’s pricing structure.
“Some providers just put everything into a lump-sum price and charge us that, but with Standard Chartered we can see exactly what we are paying for,” says the chief risk officer of a large asset manager based in Asia. “This is important because different charges affect us in different ways. Some charges might be based on the notional value of a trade, other charges on the sensitivity of the trade. Having transparency in pricing helps us decide whether we should be doing a trade in a more efficient way or not doing it at all.”
Most of the trades that Eclipse clears ultimately get backed out to London-based LCH, but this is more a factor of clients’ current workflow than any particular design. In recognition of the growing importance of Asian exchanges, and the need to provide services that clients actually want, Standard Chartered has also hooked its system up to the Singapore Exchange and the Hong Kong Exchange.
“This is a business born out of Standard Chartered’s desire to service our client base rather than a legacy futures platform, so we want to be in the local markets where our clients are and we position ourselves in that way,” says Andrew Sterry, Eclipse’s other co-head. “We recognise the importance of providing clients with access to local CCPs in anticipation of an increase in client demand for clearing in Singapore and Hong Kong.”
The other thing that Standard Chartered has to be careful about is the risk management system that underpins the new service.
“This is really important because we have to safeguard the bank. When we clear for a client we are vouching for that client to the clearing house and we are covering that exposure, so if the client defaults then it is the bank’s problem, not the clearing house’s. Having a well-run risk management approach for this business is absolutely critical,” says Brereton.
At the heart of Eclipse’s risk management system is an automated platform that monitors the risk that each client is taking on. The platform provides clients with a detailed breakdown of their delta exposure, split across different curves and tenor buckets, so that clients can easily see where their peak risk might lie. On top of that Standard Chartered sets client-specific limits, which serve as a warning that a client is taking on more risk than it can handle.
“We’re quite relaxed about the overall exposure of clients because trades are fully collateralised, but what we really have to pay special attention to is the delta,” says Brereton. “This is the amount of risk that your client puts on each day, which will not be fully margined until the following day.”
A series of triggers warns the bank that a particular client is drawing near to their risk limit. If a client has used too much of its risk quota, then Standard Chartered will call that particular client and ask if anything further is going to be put on that day.
“If they are, we might have to seek internal approval to give them temporary increase in their daily limit or ask for a bit more collateral upfront to cover the extra risk,” says Sterry. “We want to try and avoid shutting the client down completely.”