Why is it that some buy-side organisations have met earlier CCP clearing deadlines under Dodd-Frank whilst others are scrambling to meet the upcoming Sept deadline? Lynn Strongin Dodds explores if there lessons to be learned for the European firms who need to prepare for EMIR’s clearing deadline.
Despite the scramble, most buy-side participants were able to get on board the US clearing train by the March and June deadlines. There were anecdotal tales of the bulge brackets only focusing on the larger derivatives players where they had the strongest relationships. However, in many cases it was less an issue of neglect than the inability of the smaller firms to get to the finishing line in time.
In fact, a study published by SimCorp, a provider of investment management solutions and services, found that only 41% of the 60 executives from 34 global capital market firms polled in March were ready to centrally clear interest rate swaps (IRS) and credit default swaps (CDS). More than half -53% – were unprepared to do so. Respondents cited cost, collateral management, intraday reporting, systems integration and regulatory compliance as the biggest challenges in derivatives processing. In addition, many firms are still encumbered by legacy and fragmented portfolio management systems which makes it difficult to sign on.
Others missed the deadline because they were still negotiating terms with their Futures Commission Merchant (FCMs) or had their entire documentation ready but had not connected with their middleware provider. They are considered one of the linchpins in facilitating the necessary connectivity between banks, central counterparties (CCPs) and the buy side. Getting on-board is not just having all your internal ducks in a row,” says Bob Holland, senior product manager at Linedata, a global solutions provider. “It is also about having the right data and connections. However, I have not heard of anyone being turned away but instead some are taking their sweet time signing up. They are waiting to see how things are going to shake out.”
“There was a last minute rush to sign up to clearing services in the run up to the recent deadline, which caused a bottleneck,” says Ted Leveroni, executive director of derivatives strategy and external relations at Omgeo. “As a result, there were a number of firms who weren’t able to make the deadline. However, some of the smaller firms may not have selected a clearing service provider because of the expense and resource required to implement a clearing strategy.”
Charley Cooper, senior managing director of State Street Global Exchange adds, “I think as an initial matter, we did not see any clients being excluded. Everyone found a home but some clients may not have received the attention they had hoped for and their expectations may not have been met. I think one of the biggest differentiators was activity. It may not have been cost effective for certain FCMs to onboard a client that, for example, only traded one swap a year compared to a large firm which traded frequently. Also, there are certain clients that are too small and do not have the credit rating that more conservative FCMs require.”
Practice though makes perfect and by the time the September deadline rolls around, FCMs should have their on-boarding procedures, technology and documentation finely honed. This last wave includes non-commercial end users hedging commercial risk as well as pension funds and entities with a third-party subaccount structure. The first phase in March covered swap dealers and major swap participants while the second group comprised hedge funds, asset managers and regional banks.
One question in Europe is whether the buy and sell side will learn the lessons from their US counterparts? Views are mixed but if a recent report by State Street – From Readiness to Revolution – is anything to go by, it is the early movers who had the greatest advantage in negotiating the best preferential terms and conditions relating to fees and margin requirements. Those that dragged their feet were lower on the pecking order and found less flexibility on the fee front.
The sell side should also take note in that firms tended to select FCMs based on their financial stability and pre-existing relationships in order to benefit from a reasonably priced bundled service. Also, many opted for a single FCM and clearinghouse because it was simpler and less risky than choosing multiple routes.
It will be challenging though because the deadlines for the European Markets and Infrastructure Regulation (EMIR) keep moving. For example, The European Securities Market Authority (ESMA), the body responsible for EMIR’s implementation, has shifted the publication of the recommended technical standards (RTS), which determine which products are to be subject to mandatory clearing, from October 16, 2013, to March 15, 2014 and now September 15, 2014. Meanwhile, CCPs, which were to be authorised as early as April 15, 2013 under the previous timeline, now have to wait until the September date at the earliest.
The jury is out as to whether the delay could prompt buy-side firms across the board to bide their time. As Betrand d’Anselme, head of listed derivatives, execution and clearing services at BNP Paribas Securities Services puts it, “As we have seen in the US, they do not want to leave it too late as it is difficult for everyone to walk through the door at the same time. The problem in Europe is that there are no hard deadlines but if buy side firms start now then they will have a better chance of getting the best deal.”
Nadine Chakar, executive vice president and head of product and strategy for BNY Mellon’s Global Collateral Services, adds, “I am afraid we have seen this movie, with buy-side firms waiting until the last minute to get their affairs in order and sign on and I am not sure it will be different in Europe. If you view Dodd Frank as an industry fire drill, then clearly it has made a lot us wiser and we are better equipped for every eventuality. The phased implementation also helped us to adjust and adapt which has helped us make the process smoother.”
This is not only for the larger volume generators but also those farther down the line who are interested in moving up the derivatives ladder. “I think we will see FCMs focus on key clients but not to the exclusion of other clients,” says Bradley Wood, partner at GreySpark Partners. “They are looking for new revenue streams and clearing is the next battleground. The sell side is investing in recalibrating their service offering across a larger client segment, especially with the tier two, three and regional firms. There is no doubt that money is to be made and developing this service will enable them to better differentiate themselves.”
Lee McCormack, executive director, OTC clearing business development manager at Nomura, adds, “There has been a perception among certain clients that there are only five or six clearing banks out there. That may have been the case a few years ago, with a handful of larger banks who had existing prime brokerage platforms or fixed-income intermediation platforms becoming early movers. However, there is now a much larger group in the second-mover category who have built up their clearing capabilities as client demand started to increase. From our point of view the new OTC rules are a game changer and we see great opportunities in providing a top tier service to mid-size asset managers who historically have not received this attention.”
Custodians are also hoping to make a greater push into the segment. “We are seeing a number of providers and not just the sell side who have the capacity and balance sheet to enter into this space,” says Cooper. “Custody banks in particular are taking advantage of providing services such as tri-party, margin financing and collateral management to clients who might be disappointed with their current offering. In many ways it is levelling the playing field.”
Their efforts could pay off quickly as witnessed by the upsurge in activity in OTC derivatives trading in the US in the first half of the year, as the new clearing mandate was rolled out. Research firm Aite Group based on data collected from the CME Group, IntercontinentalExchange and LCH.Clearnet’s SwapClear Global, showed a doubling from January to June with aggregated open interest volumes of cleared OTC derivatives – interest rate swaps (IRSs) and credit default swaps (CDSs) – jumping from $10.7 trillion in January to $20.6 trillion by June 3.
According to Aite analyst Virginie O’Shea, US figures will serve as an outline for activity in Europe when clearing requirements under EMIR take effect. “EMIR is broader, encompassing more of the derivatives market, so it should be good to see whether there is similar pattern, or if certain categories decrease,” she said.
