By Peter Walsh, Global Head of Sales, Razor Risk.
Peter, can you please tell the Risk Insights readers a little bit about yourself, your experiences and what your current professional focus is?
I have worked in The City since 1978, gaining experiences in Banking, trading, Compliance and Risk management through business and IT led projects. Following a near 20 year career inside Banks, I moved to the Vendor-side dealing with a variety of technology solutions in CRM, Trading platforms, Systems Integration/Middleware, AML/KYC and for the last 10 years Risk Management with Razor Risk. I have been through 3 if not 4 major “credit” related financial crisis and have a good appreciation of why they occur as well as what and how Financial Institutions can do to protect themselves and their stakeholders. My current focus is on bringing solutions to the market which provide capabilities, not always readily available from in-house developed systems that integrate risk measurement, management and controls across the whole enterprise.
Can you briefly explain the importance of CCP selection post-Brexit?
Selecting one or more CCPs is an important decision for all /clearing/trading/prime brokers irrespective of Brexit. There may be some decisions to make on a jurisdiction related basis that are impacted by Brexit, but most decisions will still be looking at liquidity, accessibility and risk controls. After all with the drive towards clearing gaining momentum, CCPs become even riskier-concentration vehicles, they are obliged to step into all eligible contracts (rather than only take ones they like), so the consequences of a CCP failure could be terminal for each participant as well as the markets at large. The decision on which CCP or CCPs to do business with is therefore very important. The importance stems from the business and regulatory regimes in place rather than whether or not the UK remains part of the EU. The business and regulatory regimes that firms need to consider are:-
At the Risk EMEA 2018 Summit, you will be speaking on your insight regarding ‘Reducing the Cost of Clearing’. Why is this a key concern right now? And what are the essential things to remember?
The cost of clearing, increased capital charges, near real time Trade reporting, highly competitive markets and regulatory pressures driving trading towards clearing are all making the decision on where, what, when, who and how to trade with more complex. Take these strategic decisions alongside the need for CCPs, Clearing Brokers and direct/indirect clients to offer and prove best execution, maintain capital at reduced levels and ensure access to markets and liquidity in times of stress are maintained, means that reducing the cost of clearing is a major imperative. Other factors include:
The total cost of trading comprises a number of components, not just clearing costs. Total costs also include capital and funding costs all of which are part of the equation that feed into the ultimate decision as to what is an acceptable level of trading cost in any portfolio.
Since clearing comes with certain unavoidable costs, such as margin and clearing broker fees for the buy side and other CCP costs and capital charges for facilitating clearing for the clearing brokers, participants are keen to optimise the entire process.
In John Lund’s discussions at the Razor Risk panel session we discuss the main components:-
Why is it important to discuss reducing gross notional?
Clearing fees are typically variable and based on the value and volumes of trades. In Derivatives, the Gross Notional is often the main driver of both clearing fees and Initial Margin. Where fees for Gross Notional in the cleared world can be reduced through tools such as Compression, Initial margin offsets can also be reduced where cross margining is available for certain products at certain venues, the Gross Notional between two bilateral counterparts, trading an uncleared trade will have a significant impact of the initial margin to be posted by both parties to the trade. Other considerations may also be attached to the Gross Notional such as Credit or Debit Valuation Adjustments which in turn will also impact the cost of trading.
John Lund gives some great examples during the Razor Risk panel discussion.
What are some of the key considerations with CCP account model selection?
There are two basic types of client account available – Omnibus Client Accounts (OCAs) and Individual Client Accounts (ICAs). Some of the CCPs then offer different levels of segregation within those with features that provide different degrees of segregation.
There are two main levels of segregation within Omnibus Client Accounts:
It may be easier to port CCP Transactions and their related assets, both in business as usual and default circumstances, with a gross Omnibus Client Account rather than a net Omnibus Client Account. This is because the CCP is more likely to have sufficient assets to facilitate the porting of the CCP Transactions that relate to each client separately if it has called the margin on a gross basis. That said, different CCPs’ accounts have been designed in different ways so any decisions should consider each CCP’s information about the specific accounts to understand the exact differences.
The type of account and level of segregation will have an impact on the ability to port CCP Transactions and assets to a back-up clearing broker upon default of the main/primary clearer.
With an Omnibus Client Account, in most cases, all a clearer’s clients have CCP Transactions and assets relating to them recorded in the same Omnibus Client Account. All the clearer’s clients will have to agree to use the same back-up clearing broker and the back-up clearing broker will have to agree to accept all of the CCP Transactions and assets recorded in that Omnibus Client Account. It is therefore likely to be difficult to achieve porting should the primary clearing broker default in relation to an Omnibus Client Account.
It should be easier to achieve porting with an Individual Client Account, because the bank/trading firm can appoint a back-up clearing broker with respect to their own CCP Transactions and the related assets, making it easier to port to the back-up clearing broker in the case of a default by the primary clearer at a particular CCP.
It should be noted though that under the OTC approach, CCPs are generally only offering gross omnibus or ISA accounts. Net omnibus accounts are not currently generally available. The protection required for OTC will be far more important than that for ETD as the IM is going to be much larger. For this reason, some CCPs are starting to offer full segregated accounts e.g. EUREX, ICE with sponsored principal and now LCH, which is another growing consideration for CCP choice as these accounts are designed to allow the buy-side firms to have direct access to the CCP to some degree reducing risk further (although the sponsoring Clearing Member will still have operational responsibility).
The major considerations will require legal advice as well as risk appetite awareness when making the decision. Factors impacting the decision include:-
How do you see the risk landscape evolving over the next 6-12 months?
6 – 12 months is not a long time in Risk Management, so the landscape is not going to shift too much. I think there will be some pinch points that need to be considered:-
In general though I believe we will see the coming together of Risk (middle office), Trading risk (front office), Treasury/Liquidity/Collateral/Funding (back office) into a strategic vehicle (Balance Sheet Optimisation), where the winners will bring each of these functions closer together, reducing technology costs and optimising profitability whilst the “also rans” will try and maintain the status quo believing change to the BAU environment is either too expensive or too difficult.
I can see a new paradigm emerging, where different initiatives will merge together as firms seek more cost effective solutions with re-useable capabilities, delivering incremental benefits regularly in shorter time frames rather than massive “big bang” type projects which take years to fructify and require massive investment commitments and use of scarce internal resources.
The type of approach we will be discussing during our session at the event is a perfect example of smaller projects impacting 2 or 3 areas with great payback in terms of time and budgets…..
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