The trade clearing industry generally likes the EU market trading rules’ proposed update, but it has much less enthusiasm about a provision based on the policy’s plan to take back control of EU trading in the post-Brexit context. Experts at an Efama event held online last Wednesday said it will increase costs, pose operational challenges and disrupt the practice of ‘block trading’, with one labelling it as an “import tax” forcing the market to “import liquidity”.
“What active account is essentially saying is that it forces markets to trade at Eurex, which means that you’re forcing a market to essentially import liquidity from LCH,” said Pierre-Antoine Masset, counterparty manager and product owner at Nordea Asset Management. If this is added to increased operational costs, he said, ”It really sounds like and smells like an import tax that European market players would have to pay for that liquidity.”
The Eurex Exchange is a Frankfurt-based international exchange owned by Deutsche Boerse. LCH is a London-based clearing house group which has an EU subsidiary. The EU proposal, part of its EMIR 3.0 proposed reform package, would oblige EU-based banks, insurers, pension funds and governments to hold an active account at and make certain trades through an EU-based trading house. This would, in theory, increase trading via Eurex, and decrease it via LCH’s London operation.
Huge backload
“If we are mandated to clear everything at Eurex, it means that we need to set up all the risk,” said Masset. “There is a huge kind of backload of onboarding to be done on that.”
“For this kind of logic, we would have to build into the portfolio management but also the trading system and be in a position that it’s supported downstream in all of the further settlement processes and accounting systems,” said Christian Schmaus, senior policy and regulatory affairs advisor at Allianz Global Investors. “It sounds easy, but it’s quite challenging actually to come up with this methodology and embed it into the trading and portfolio management process.”
The obligation to have certain trades clear in the EU will also disrupt the industry’s practice of block trading, in which the trading firm gathers together trades from funds in a given strategy, to come up with one larger trade that is executed and allocated to the respective accounts. This will increase costs, participants stated.
Block trading issue
“Now in this kind of block trading, this won’t work, obviously if a part of that would have to go to an EU CCP, whereas the other parts go to a non-EU CCP,” said Schmaus. “Because of the different pricing spreads and so on involved, we would have to somehow split the blocks initially.”
“If we were to move the euro swaps out of LCH and move them into Eurex, what you then find is that you end up paying two separate margins at two different CCPs,” said Nafisa Yusuf, director for market structure at BlackRock. “But you find that the margin at LCH increases because you have fewer netting opportunities.”
“Netting” in finance is a way of offsetting outstanding payments or transactions against each other so that only one payment or transaction needs to be made instead of several.
Schmaus at Allianz said he could prefer ensuring organic growth by increasing EU CCPs’ attractiveness rather than legislating EU clearing. “I think that mandating will not add much to the financial stability, from my perspective.”
Other elements of the EMIR 3.0 package got more positive reactions.
Improved product availability
“We do see tendencies that will improve the product availability,” said Schmaus, who said his firm sees “CCPs being in a position to come up with new product ideas, bring them to market faster and thereby allow a broader range of products.”
Schaus also pointed to the benefits of the proposal around margin model transparency. “Having the transparency of margin models from the CCP to the clearing broker and finally to the asset managers/buy side, as well as the clients or end users of the products…is fundamental to understand and plan for cash management and forecasting.”
Having this transparency “is very positive…in light of further growth,” he said.
Managing liquidity risk
“Transparency and predictability of the CCP’s initial margin are really important in managing liquidity risk, and ensuring that our clients can cover their margin calls during a strained environment,” said Yusuf of BlackRock.
Barry Hadingham, head of derivatives and counterparty risk at Aviva Investors identified an aspect of the market infrastructure legislation as “a competitive advantage”. In the EU, he said, “all clearinghouses are effectively treated as credit institutions…which gives them access to central bank liquidity,” he said.