Banks shun Emir's indirect clearing service

Service was designed to help small firms comply with clearing rules, but banks say they will not offer it under the conditions laid out in Emir

Esma headquarters

Banks are still incapable of offering indirect clearing for over-the-counter derivatives more than two years after rules for the service were added to the European Market Infrastructure Regulation (Emir) – an attempt by regulators to ensure small OTC market participants would be able to clear. Big banks say the terms on which they would have to offer the service make it commercially unviable.

Indirect clearing allows the clients of a clearing member to take on clients of their own, but the member remains the ultimate guarantor of the risk, and Emir requires both groups of customers to be treated the same. That means giving the so-called end-clients a choice of at least two forms of collateral protection. The first of these, omnibus accounts, is cheaper for clearing members to offer; the second, individual segregation, is more expensive. Members are so far refusing to offer individual segregation to end-clients, which they have no direct contact with, and argue the European Securities and Markets Authority (Esma) will need to intervene if anything is to change.

"If we want indirect clearing to work, Esma needs to make it very clear to clients what they are getting and what they are not getting. We cannot offer the same facilities to end-clients that we offer to our direct clients," says one head of OTC clearing at a European bank in London.

Another London-based OTC clearing head echoes that sentiment: "Esma should recognise that an omnibus account is an acceptable solution for end-clients. Banks have been asking this for years, but nothing has changed so far."

The standoff looks set to continue. Esma is still expecting the industry to roll out indirect clearing services before deadlines bite.

We cannot offer the same facilities to end-clients that we offer to our direct clients

Under phase-in proposals published by the regulatory authority on July 11, most market participants will have 18 months to start clearing once its rules have been finalised. In practice, that deadline is expected to arrive in the second half of 2016.

Asked about the lack of movement on indirect clearing, a spokesperson for Esma says: "We believe the proposed clearing obligation and relevant phase-in will provide a good incentive to speed up this work."

Provisions for indirect clearing were added to Emir at the eleventh hour, first appearing in proposed form in June 2012, and were instantly controversial. Central counterparties (CCPs) have strict membership criteria, meaning the vast majority of firms subject to Emir's clearing requirements – estimated at multiple thousands – will use a client clearing service offered by one of a handful of large banks. These services impose capital, funding and leverage costs on the member firm, and regulators feared many smaller firms would not transact enough business to make them attractive clients.

Indirect clearing is an attempt to solve this problem, but while regulators chose not to make the service compulsory – an early possibility – they insisted the end-clients should have access to a CCP on the same terms as a member's other customers. That means giving them the same choice of collateral segregation models required by Emir for direct clients.

In an omnibus account, positions cleared by multiple clients are offset against each other, with the clearing member posting the net collateral requirement to the CCP, reducing the member's funding burden and leverage exposure. The reduced cost comes with extra danger, however. If one or more omnibus clients default and the associated margin is not enough to cover the losses, margin from other clients is consumed on a pro rata basis. Segregated accounts are safer as there is no mutualisation of risk with other clients, but the burden imposed on the clearing member is also higher, and banks say they are unwilling to offer the accounts blindly.

"I think there is a legitimate concern from regulators around small clients not having access to clearing and I have sympathy with that. But if it doesn't make commercial sense to offer clearing to everybody because it's not a good use of my capital, leverage ratio and balance sheet then I'm not going to offer it," says a London-based clearing specialist at one international bank.

Clearing members are working on services that might expand CCP access to smaller firms, but these are not structured as genuine indirect clearing offerings - the end clients would be known to the clearing member, and the two would be bound by a contractual agreement.