By OTC market subject matter expert Sol Steinberg
As central clearing and recent changes to the over-the-counter (OTC) derivatives markets in the US and Europe have had their impact on market participants, firms are now faced with increasing costs and a drag on overall profitability. Regulators for their part say the changes are necessary to minimize systemic risk to the financial system.
Yet, each new wave of regulation adds layers of complexity to an already complex system. Regimes such as the European Market Infrastructure Regulation (EMIR) have placed new pressures on the nascent clearing community by requiring both sides of a trade to report all cleared positions to trade repositories. This additional step is adding more to the costs of these transactions, and are bringing discussions of expenses to all facets of the investment discussion.
Regulatory changes are forcing firms to find new ways to keep costs low either through new IT systems or by exploring new business models. Both buy-side and sell-side participants are looking at ways of pooling their resources as well as drawing in the expertise of other parts of the market like Futures Commission Merchants (FCMs) and custodians.
The areas impacted the most are portfolio performance, compliance, cost of clearing, risk management, operational complexity, margin management, staffing/capacity, reporting and collateral management.
Compliance is having a direct effect on their business decisions. Complexity and margin requirements followed close behind. Collateral requirements can have a significant impact on both side of a trade with players themselves worrying over what they have on hand, while exchanges must remain vigilant in monitoring overall collateral in order to avoid concentrations of risk and credit – now under heavy scrutiny from regulators.
Another key issue driving compliance concerns is uncertainty over correct implementation of requirements. Central clearing mandates are putting pressure on all sides of the market as both players and clearers work through the trial and error of implementation. Still, the bulk of market participants say that despite the difficulties of implementation they are on pace to meet deadlines. Exchanges and regulators feel they are making good progress implementing regulatory changes while HFT firms were the largest cohort reporting problems such as lags in meeting compliance requirements.
NEW BUSINESS MODELS
As participants work through these issues clearing utilities are emerging as one new solution. Clearing utilities can perform functions that were typically done in house everywhere – but on a bulk rate, allowing the industry to realize scale. While clearing utilities are still nascent within the market, most capital market participants are interested in exploring their use in their business. Buy-side firms especially, indicated interest in outsourcing these non-core functions to a third party.
While there is strong interest coming from all sides of the market in these types of utilities, it would require players to work together, and play nice with each other. Based on recent history getting the industry to act together may be difficult, the bottom line is that considerations may outweigh egos. Watch this space.
