European Central Counterparty Limited (EuroCCP) called today for the adoption of a single standard Convention on Interoperability that all central counterparties (CCPs) would sign, to accelerate the seamless connectivity across Europe needed to free market participants to choose where their trades will be cleared and settled — and position the European capital market more competitively as the current recession abates.
The Convention, designed as a framework agreement, would require CCPs to agree on risk management arrangements that are transparent to market users, platforms and regulators.
"Although some progress has been made on interoperability, there is insufficient transparency in how new risks caused by interoperability are managed. It is not sufficient that costs come down through competition to realise the benefits envisioned by MiFID and the Code of Conduct," said Diana Chan, chief executive officer of EuroCCP. "The arrangements among interoperating CCPs must be robust, and complete transparency in how CCPs manage their exposure towards each other is important for systemic safety. As the world economy begins to emerge from recession, we should ensure Europe is well positioned to attract the flow of investment capital based not only on greater efficiency and lower cost, but also rigorous risk management processes among a network of interoperating CCPs.
"While a number of Europe’s CCPs, including EuroCCP, have announced plans to interoperate, the negotiations are bilateral. Four CCPs interoperating require six bilateral contracts. Six CCPs interoperating will require 15 contracts," said Chan. "By creating a Convention that incorporates common standards around key elements of risk management, change management, and dispute resolution, we believe CCPs can join together in greatly simplifying and expediting the achievement of interoperability, to the benefit of market participants throughout Europe."
Facilitating market evolution
Spurred by implementation of MiFID [Markets in Financial Instruments Directive], the post-trade landscape for European equities is evolving rapidly. The creation of new trading platforms and new entrants to central counterparty clearing have already lowered clearing costs significantly for market participants.
Among the various interoperability plans announced by CCPs are: EuroCCP, EMCF and x-clear will have interoperability to serve NASDAQ OMX users; EuroCCP, LCH.Clearnet and x-clear will interoperate to serve Turquoise; and EMCF, LCH.Clearnet and x-clear plan to establish interoperability to serve Chi-X.
However, the objective of the European Code of Conduct for Clearing and Settlement and the Code’s Access and Interoperability Guideline is to introduce competition. The absence of a standard legal agreement that would harmonise CCPs’ approaches to critical implementation of risk management among interoperating CCPs could handicap meaningful competition. An Interoperability Convention would further the goals of the Code of Conduct ― that is, to offer market participants freedom to choose their preferred provider of services separately at each layer of the transaction chain, to establish a strong European capital market, and to allow investors the choice to trade any European security within a consistent, coherent and efficient European framework.
Promoting risk management
In addition to simplifying the establishment of interoperable links between CCPs, an Interoperability Convention will also strengthen risk management in Europe’s interoperating network. By making transparent critical provisions in risk management — for example, the framework for posting margin and default management — a Convention will ensure that risk is shared even-handedly and transparently between interoperating CCPs, rather than offloaded by one CCP onto another.
EuroCCP believes the Convention should be developed in collaboration with other CCPs who have already agreed to interoperate.
"We owe it to our customers and to Europe’s investors to find a faster solution to this issue. There must be complete transparency in how CCPs manage their exposure to each other, so that trading venues, market participants and regulators have the full picture and comfort that the risks are under control," Chan said.