The future of clearing: Part one
The future of clearing: Part one of a three-part series by Hans-Ole Jochumsen, President, Global Trading and Market Services, NASDAQ OMX.
Clearing stands at an important crossroads. Regulatory reform is prompting unprecedented change and the upshot will be a very different clearing regime to what we have today. The overall aim is to create greater stability and transparency; the real challenge will be achieving this while balancing the needs of participants with those of the market and society.This will require some careful navigation of the detail and, crucially, a re-think of clearing practices. While regulators iron out the specifics, central counterparties (CCPs) have an important role to play in defining this future. Three areas stand to have the greatest impact – capital efficiencies, investor protection and technology innovation.
The rise of cross-margining
Achieving capital efficiencies will remain an important consideration as participants look for ways to do more with less. Today, this is largely related to margin levels but that is all about to change.
Decisions around what to trade and clear will be influenced not only by the product but also by the levels of margin required. This will become increasingly important with mandatory clearing, as participants will clear more products while having to hold larger amounts of capital.
Cross-margining has emerged as a valuable tool to tackle this challenge. Currently, this is done to varying degrees across the industry, whether cross-margining across over-the-counter (OTC) and exchange-traded products or net margining across multiple asset classes. It is where many CCPs have been able to differentiate their offerings based on their risk appetites. However, regulations will harmonise margin levels. Therefore, most participants could, eventually, achieve the same levels of efficiency through margining, regardless of where they clear trades. As a result, participants will look for other ways to make the best use of capital.
Optimising collateral
Collateral management, while not new, will need to evolve to meet this need; it is this that will drive future capital efficiencies. Opinions and predictions differ on whether there will be a collateral shortfall and, if so, how great it will be. The reality will depend largely on how well these assets are managed; the ability to optimise collateral in ways that are not related to margins will become highly valued.
On the broker side, efforts to address shortfalls on client inventories or to transform ineligible assets into suitable collateral will have a big impact. On the CCP side, there are several possibilities that could emerge.
One of these is integrated calculations between margin portfolios and collateral portfolios. This would allow full offsets where a participant holds the underlying security when trading, for example, an equity option. Calculating the exposure in a clearing system participant’s portfolio against its underlying collateral is true collateral management.
Other opportunities include optimising cash, with total netting across all cash flows and full straight-through-processing (STP). This would apply to the entire cash flow, from instruction and confirmation to reconciliation of individual transactions. As a result, any excess collateral in cash could be used to cover cash settlement while a positive cash settlement could cover the margin requirement.
