When MiFID first emerged into the mainstream, many of us focussed on developing smart routing systems that could navigate the new fragmented liquidity landscape. Over time, these smart routers have become increasingly sophisticated and now take into account both lit and dark venues and assess them against a dazzling array of metrics. Left behind in the gold rush was the seemingly dull world of clearing, where the contribution by Europe’s clearing houses was pretty much limited to waving an “interoperability at some point in the future” banner.
Well this looks like it may well be set to change.
BATS Europe has recently announced that it will allow its market participants to choose which clearer they use (which shows that interoperability has now become a reality). By offering choice, BATS is disrupting the vertical silo model whereby exchanges own (and extract fees from) every step in the trading process. It will also allow participants to take advantage of different clearing deals they can negotiate by tagging particular orders to go down one clearing route or another. On top of this, the regulatory pressure to see more products (such as OTC derivatives) cleared centrally has ignited interest in the space, and is why LCH Clearnet is reportedly mulling over a number of offers from exchanges and others keen to further their ambitions in this direction.
So, suddenly the world of clearing looks more exciting as the promise (threat) of real competition looks like becoming a reality. The European Association of CCP Clearing Houses lists 24 members on its website and, as interoperability bites, all these firms could be providing the same generic service (namely venue and asset class agnostic clearing). So it looks like we might be heading towards a situation of over supply, especially when compared with the solitary DTCC that performs the same function (at least for equities) in the USA.
Do we really want to see the same levels of cut throat competition between clearing houses that we have witnessed amongst trading venues? Will European clearing houses entice firms to clear through them by offering lower and lower fees or ever more speculative offsets?. And, more importantly, is this what we really want given that the primary role of a clearing house is to act as the last bastion of sanity when markets start to melt down? Sure, we could all use better margin offsets and more efficient use of our precious capital, but maybe it’s even more important that a clearing house never fails in its role as buyer to every seller and vice versa.
Steve, yes it is time! This has most certainly developed beyond the dull category and has become a key focus for many. You ask “is this what we really want”, and I think it is worth recapping just how inefficient things are today.
There are 3 areas of commercial focus on interoperability.
(1) Firstly we today have inefficient settlement processing. It is possible today to trade say a French equity and face four CCPs at the end of each day. We net our trades to each CCP to reflect the actual resulting net credit and settlement exposure, and settle to each one. That means we have four times the settlement costs relative to using a single CCP – ie a 300% markup vs what we sensibly should be paying.
(2) Secondly we then also have an overstated credit and settlement exposure to the CCP world. A trading house such as Nomura will be trading in and out of stocks for clients all day, and should reasonably expect to compress to a single risk exposure at the end of each day. In a simple example we could buy 100,000 shares on one platform and sell 80,000 on another. My actual risk is 20,000, but in today’s world I am given an actual credit and settlement exposure, and charged margin on 180,000 shares. Creating these false credit exposures is far from ideal.
(3) Thirdly banks such as ours with material volumes should be able to seek economies of scale through the use of a chosen provider. By spreading flow across multiple providers we are removing the commercial efficiencies that come with competition.
It is therefore key that with trading venue fragmentation we address the clearing space. This is why Nomura will be taking up the choice offered by BATS and other venues to follow.
If I can choose a CCP for each market, I can choose the same one and net away my risk. However my counterparts is likely on other CCPs also, so the risk that each CCP had on me, would be transferred to risk between CCPs.
To carry that risk, there is likely a premium in costs, most likely passed back to me.
Maybe the risk premium between CCPs will be low, since they are “to big to fail”, and there will be some benefit anyhow.
I like to compare it to mobile networks. It is always cheeper to call someone on the same network than calling someone on the other. The premium between “CCPs”.
It would be nice to study this in detail.
As Steve said before, if you are big, you have scale. If you are not, I supposed you will anyhow use a DMA broker and/or GCP that solve all this for you. Smaller players have to move higher up in the food chain.
The merger mania will continue.
Thanks to both of you for your comments – I am sure that Nomura is not alone amongst the tier one firms that would like to see greater efficiency in clearing. Especially as these are the same tier one banks that are being asked to make more capital available for their everyday operations by the regulators.