The concept of using central counterparties, or a clearing house, has been very much in the news over the past couple of weeks. At times, it seems there is a propaganda campaign being waged by those in favour of CCPs and those who prefer the bilateral credit-trading model that dominates FX.
Both models have their merits and their weaknesses. It is often claimed that trading on regulated exchanges is safer than in OTC because of the use of a CCP as risk mitigator. However, what the CCP also does, as the SocGen debacle has shown, is effectively disguise who is the counterparty to the other side of trades.
It is inconceivable that SG would have been able to rack up such a huge position and loss in a bilateral, OTC market because it would have inevitably filled many of its credit lines. Furthermore, compliance officers at its counterparties would surely have contacted the bank and asked if the trading was legitimate. Eurex did this, but SocGen ignored it. Would it have been able to ignore multiple requests from counterparties as easily as from a single clearer?
Talking to a very prominent hedge fund this week, I heard that it has a desire to see a CCP in FX, provided that it can net and then settle through CLS. Again, risk mitigation is a factor, but also that old chestnut of making trading cheaper. I’m sure people have done the maths, but use of a CCP is not free. The CME’s headline rate for clearing FX is $0.07 a contract, or around $0.56 a million. So, just how much cheaper would it be to net through a clearer and then settle through CLS? I’d like to know.
Even if there are real cost savings to be made, the reality is that the regulators want CLS to exist. Furthermore, would certain countries really be happy to see the majority of transactions in their currency cleared offshore? I can’t see the Japanese authorities, let alone the Chinese, buying into that idea.
Another consideration is that if you trade through a monopolistic clearing house, the position has to be unwound through it as well. It’s not like trading on EBS and unwinding it on Barx, Autobahn, HotSpot or any other venue with the best price. So be careful what you wish for.
