In a Q&A, Murex’s Dania Fakredin-Viatte explores how client clearing service models can utilise technology to support pricing, risk management and collateral functions that make up the building blocks of a robust and efficient client clearing service for OTC derivatives.
Q. What does a client clearing service model generally look like and what functions are included?
A good client clearing service must provide at least the following features:
- Automated trade processing business rules coupled with connectivity to execution and matching platform, clearing houses and trade repositories
- Real-time monitoring of trades and positions across central counterparty clearinghouses (CCPs)
- Real-time collateral monitoring across CCPs and Clients
- Client position, risk and exposure across CCPS on-line views and reports
From this perspective, the client clearing technology must greatly leverage from the widely used pricing, risk/collateral management and global operations in the capital markets.
Moreover technology can offer a client clearing service provider real business differentiators when it is designed to offer natively a wide variety of products and asset classes, combined with a robust risk and collateral management built on a massively scalable and open architecture to cope with increasing volume environment.
Q. Connectivity is often the first challenge in building a client clearing service? How do providers determine what clearinghouses they will connect to and what are the factors to be considered in this assessment?
Taking into account the recent regulatory landscape, there are many local or international exchanges that are interested in offering central clearing for Over-the-Counter (OTC) derivatives to members and clients. Nevertheless, and as of today, we believe there are two categories to consider:
- Exchanges or clearing houses that have been clearing OTC derivatives for years with a substantial market share on a specific asset class, such as LCH.Clearnet for interest-rate swaps (IRS) and the IntercontinentalExchange’s ICE Clear for credit default swaps (CDS).
- Exchanges that have recently launched OTC clearing services or about to do so and have the capacity to compete with the two previous institutions because of their wide experience in clearing generally, such as the Chicago Mercantile Exchange (CME) and for geographical reasons like, Singapore Exchange (SGX), Hong Kong Exchange (HKEx) and Shanghai Clearing house.
Connecting to the previously cited exchanges is a must for an OTC clearing technology provider, in particular under the US clearing model. And the current European model should also cope with the connectivity to the affirmation/matching platform, such as Markitwire, whereby the trades are first submitted to the member after being matched for acceptance/rejection and sent to the CCP for clearing.
In a centralised clearing environment, establishing a clearing infrastructure across product types, able to connect flawlessly to multiple CCPs and affirmation/matching platforms could be viewed as vital to maintain a competitive and integrated offering to clients.
Q. What are the technological challenges in combining both listed (e.g. futures) and OTC derivatives businesses under a single client clearing service infrastructure?
Clearing listed products has been widely done for years through exchanges, Future Commission Merchant (FCM) and banks futures entities. At first sight it seems easy to expand the technology already used for exchange-traded products clearing to the OTC world; after all clearing a future sounds similar to clearing a swap. Digging further into details reveals that this is not as easy as it seems. Clearing OTC derivatives relies on a flexible valuation framework that makes it seamless to adapt to different conventions, or new pricing requirements, like the use of Overnight Index Swap (OIS) curves and multi-curve calibration for swaps.
Alternatively expanding an OTC clearing technology that already covers the valuation and the basic margin components for listed products, such as liquidation margin or variation margin, would be at lower cost.
This being said, clearing members are moving towards merging both clearing businesses to offer cross product margining to their clients along with a consolidated reporting across asset classes, therefore combining both businesses from a clearing infrastructure perspective could become crucial in the next few years.
Q. What are the added-value services of a client clearing service? How can firms differentiate clearing services to capture more clients?
Pro-forma margin computation is an important added-valued services included in a client clearing service offering. Pro-forma margin computation enable a client to assess the impact on its margin requirement prior to submitting potential trades for clearing; offering this functionality will help clients anticipate to a certain extent the liability they need to post for a set of potential trades.
Moreover, it is vital for a client to avoid increasing margin costs due to low netting or cross-product margining ability. Providing a clearing service with cross margining capabilities across products within the same asset class, between two different asset classes or between OTC and listed products, is a clear added value for clients whose highest priority is to achieve most margin efficiency.
Q. How can financial institutions better prepare clients for using a new clearing service?
Clients are supposed to execute their trades in electronic platforms that are connected to the CCPs and member clearing services. On the one hand, when a trade or a block trade is executed by the client and sent to the CCP or the member (non US model) the clearing service has to manage efficiently and with high speed the reception of the orders and executions, the request for quote (RFQ) communication and prices, credit lines allocated to the clients and clearing notification back to the execution platform and the client.
On the other hand, at the beginning many small clients won’t have a direct access to the electronic platforms; providing the possibility to use the member’s network and clearing service to execute and clear their trades would ease clients on-boarding on a new clearing service. Therefore the member clearing service’s connectivity should be able to manage trades received from various client networks to be matched and cleared, and the subsequent clearing submission and workflow within a low latency environment.
Q. Are there any upcoming market changes or issues that will impact how client-clearing models are used and how will services adapt as needed.
There are many. Connectivity to CCPs and electronic platforms, high speed for execution, real-time registration of cleared trades, transparency in reporting, collateral account segregation are all issues that need to be ironed out and will have a direct impact on how clients use the clearing services of third party providers such as brokerage firms.
One of the ways Murex is accounting for all the above-mentioned changes is to package best practices based on the work already completed with major market participants. With this best practice in mind, we can offer a consistent clearing framework to clients that scales and integrates seamlessly in real-time with high level of controls and automation.
