DerivSource’s editor Julia Schieffer speaks to both Dr. Tina Hasenpusch, CEO at CME Clearing Europe and Cedric Gillerot, Director, Product Management and Collateral Management at Euroclear who jointly offer an update on the establishment of a full segregation model and the new solutions under development, which can expedite the transfer of margin and better track movements necessary for an efficient cleared derivatives operation.
DS: What do you think is biggest stumbling block market participants are still grappling with when it comes to preparing for CCP clearing?
CG: For us at Euroclear we are working closely with the market and all its constituents, namely buy-side, clearing members, CCPs and custodians to find a solution to address the complications arising from segregation models but the needs and thus solutions will vary somewhat by the model chosen.
To explain the models briefly, there is the individual segregated option, which has implications from a central counterparty (CCP) perspective because under the European Market Infrastructure Regulation (EMIR) they have to maintain full segregation in their own books, which can impact the transfer of collateral from the buy side to the CCPs.
The other choice is the omnibus segregation (OSA) model where the clearing member has the bilateral collateral flow. It is important in terms of managing the flow of collateral that you monitor the solutions across the chain. This means transferring as well as tracking the collateral. Another model discussed is the quad party or full seg arrangement, which is a variant of tri-party repo except that there are four separate legal entities – the client, clearing member, CCP and collateral agent. However, it eliminates a step in the chain in that the clearing member is not an active part of the collateral flow. The collateral moves directly from the buy-side and its custodians to the CCP.
We are discussing these different models with all market participants in order to accommodate their various requirements and to achieve the most effect outcomes in terms of the collateral, segregation of the collateral, and real time reporting.
DS: Focusing on full segregation for a moment, why was it important that the Bank of England gave the CME’s full segregation model the green light? And is full segregation still part of long-term plans despite EMIR delays?
TH: Last year, CME Group’s European clearing house, CME Clearing Europe, became the first central counterparty (CCP) globally to receive the regulatory green light for the full segregation client protection model with enhanced protection for all bankruptcy scenarios. The approval was an important enabler for us because it spurred interest from market participants in the legal opinions that we had solicited to confirm the risk weighting for this model. Although they are subject to final confirmations, the individual segregated model stands at a 2% risk weight while our full segregation model is at a 0% risk weight. This compares to the current 4% of the omnibus segregated account (OSA) model.
As for the extended timelines of the regulatory mandate to clear, the delays have had some impact in that IT investment decisions have been realigned with the new timelines although on the whole the market is starting to gear up for the central clearing mandate under EMIR. Amongst many market participants, there is a desire though to take the route of least resistance, which may explain why the OSA model is the current standard across the European buy side. I think that’s understandable as the industry can only stomach so much change whilst gearing up towards the clearing mandate; however, I believe the buy side will return to their original objective, which is asset segregation and protection in the medium to long run. Full segregation is clearly not off the agenda but is simply in a way ‘parked’ for when the industry as a whole is ready to implement individual segregation with full segregation being the next step in the evolution.
DS: I understand CME Clearing Europe has a full segregation model in progress for the Swiss market. Can you explain what is happening to our readers?
TH: We have a full segregation model with SIX Securities Services in Switzerland that will act as a template going forward. CME Clearing Europe and the post-trade arm of Swiss exchange operator SIX Group forged a partnership last May to build off an existing platform to manage collateral in support of centrally cleared derivatives trades. The service enables market participants to place collateral directly in CME Clearing Europe’s account at its central securities depository (CSD). The service not only provides greater transparency on how collateral is being used and what is available to meet margin requirements but also offers enhanced segregation, and elimination of transfer risk.
We have been working with a group of ten banks, a law firm and a handful of insurance companies in the country over the last three years to structure this model. And we now have the building blocks in place and together with SIX SIS we are ready to start the onboarding of clients into this structure this year. Swiss insurance companies with tied in assets are ahead of the curve, having already received the green light for using CME Clearing Europe’s full segregation model from the Swiss Financial Market Supervisory Authority (FINMA) off the back of our regulatory approval.
The Swiss preparedness for full segregation and asset protection is driven by the anticipation of differences in execution costs rather than the CCP clearing mandate as such because they are not subject to EMIR and have their own version of financial regulation called FinFrag. It is still early days but I believe though, as always with innovation, once the processes and costs are formalised, full segregation will become one of the standard models for asset segregation for Switzerland and Europe generally.
DS: How can more efficiency be created for both clearing members and custodians?
TH: Under EMIR Article 47.3, CCPs need to keep their collateral in a CSD account. So far, few CSDs have established direct relationships with the buy side; so the integration of traditional custodians in the workflow is still an important objective in the post EMIR world either for the purposes of facilitating the holding of clients’ assets at a CSD or for collateral management services. CME Clearing Europe has been a pioneer in this space by working on structures that allow the integration of custodians into the value chain. We work with a variety of custodians who are offering clearly defined new services for their buy-side clients. One example is BNP Paribas who was one of our early partners on full segregation and overall a pioneer in the space. BNP is looking at ways to offer innovative services for the different segregation models.
We are also placing strong focus on supporting the clearing members in developing full segregation models, which is offering operational, safekeeping and cost efficiencies for the dealers themselves. For example, full segregation, or at least our model, enables the direct pass through of assets from a client account into ultimately the CSD account or from the client to a CCP without being transferred through a clearing member account. The main benefits are removing the need for additional transfers as well as lifting the burden for clients who have sufficient eligible assets to receive cash prefunding from the clearing member themselves.
In addition, we have a long-standing partnership with Euroclear to enable clients to more efficiently allocate their non-cash collateral, such as by leveraging collateral management capabilities that Euroclear or a custodian might offer. Of course, some of the larger clients may have the capacity in-house to make their own assessment over the most effective ways to move their assets between their bilateral, cleared and repo transaction needs; but that is the exception rather than the norm. Euroclear’s tri-party service and direct transfer function offer benefits and efficiencies that are very attractive to all market participants.
DS: What role can market utilities play with direct transfers?
CG: The direct transfer function delivered greater control. In other models, the client would know what the CCP sees as eligible collateral and what the clearing member accepts. The difference with the full segregation model is the nature of the direct transfer, which can be done in real time and through tri-party arrangements, offered by industry participants such as Euroclear through our collateral offering.
Direct transfers also helps usher in the new era of collateral management which involves the bilateral velocity of allocating collateral and the substituting of assets in real time. The process can be facilitated by custodians or other firms along with the infrastructure being supported by CCPs and CSDs, including Euroclear’s global Collateral Highway. This is a break from the past whereby in a normal clearing model, a client would give assets to clearing members once a day, and if there was the need for substitution, it would happen the next day in line with the clearing cycles.
There is also an operational benefit because it is a burden for clients who have sufficient eligible assets to pass them to the clearing member. With direct transfers the process becomes more harmonised and efficient which is beneficial to both clients and clearing members.
