The changing face of derivatives clearing

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Regulators want to shift the risks of such trading away from banks and towards financial institutions and are also pushing for more trades to be cleared centrally, writes Graham Shuttlewood, product manager at RBS.

Graham Shuttlewood, product manager at RBS

But the rapidly growing number of central clearing houses has raised some concerns – there are now more than 20 of them around the world as each market looks to set up its own.

Each central clearing house requires a pool of liquidity from its members — not just for meeting margin calls but also for guaranty funds.

The more of them you use the more ‘spare’ collateral you’ll need and, with enormous sums quoted – figures in the hundreds of billions of dollars have been suggested – several commentators have questioned where the additional pools of liquidity will come from and what the impact might be on other markets.

Also, using numerous systems at different clearing houses means more bureaucracy and potentially more operational risk.

Commercial banks and regulators are also addressing other risks that arise when using clearing houses. An example comes with margin calls in ‘next day’ value currencies in the UK, such as the Czech koruna and the Hungarian forint.

The clearing houses have been under pressure to change the rules around these currencies, which are not traded in London and therefore take an extra day to go through. The related currency purchase is agreed on a specific date and the settlement takes place the next working day.

Under the current system, clearing houses ask the bank to confirm by 9am on the day of the margin call that they will make the payment even though it won’t be paid until the following day. This puts the bank at risk in the meantime. If their client, the member, fails that day the bank is still obliged to make the payment the following day.

This flies in the face of the Bank of England’s drive to move risk away from commercial banks and on to the clearing members, which has not gone unnoticed by the banks and clearing houses.

At least one clearing house has listened to these concerns and taken action. When the changes they’ve proposed are made within the next 12 months, banks will still confirm the payment on the day but it will only become irrevocable the next day. So the bank can revoke the instruction in the event of the unthinkable happening to their client.

Also, last year the concept of Extended Member Liability was introduced — again moving some of the risk away from commercial banks and back to the members.

Only when the margin call is safely lodged in the clearing house’s bank account, often a central bank, is the members’ liability extinguished, rather than when it is sitting in an account in a commercial bank. Again, this initiative was led by the regulator.

These risks aside, commercial banks welcome the overall push by regulators towards central clearing and greater responsibility by the members for the risk.

Banks see their primary role as providing payment systems for these trades and do not necessarily want to become the lender of last resort if problems occur.

They may want to assist a particular client but feel they should not be forced to just because problems arise from a trade.

There is an enormous amount of regulatordriven change around clearing trades. It is vital that financial institutions stay on top of these developments and realise that the risks involved are now theirs to manage.


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