Central Counterparty Clearing

The recent market crisis culminating in the collapse of Lehman Brothers and subsequent rescue of a number of institutions has caused a fundamental change in financial markets. Some of this has been driven by risk aversion by both banks and end users and some of this is being mandated by legislators. With respect to the latter point there has been specific announcements from the G20 including the requirement that the use of Central Counterparties (CCPs) for OTC derivatives is “a good thing” and those financial institutions that do not novate their OTC derivative portfolios to CCPs will incur substantial capital charges from October 2012. The impact is far-reaching, as defined by a recent EC consultative document:

"The clearing obligation would apply to 'all financial' counterparties. This term includes regulated financial institutions: all investment firms, credit institutions, insurance undertakings, reinsurance undertakings, undertakings for collective investments in transferable securities (UCITS), institutions for occupation retirement provision and alternative investment funds managers as defined in existing or pending EU legislation. These firms would have to become clearing members or a client of a clearing member."

It is not only regulation that is influencing these changes. There is a genuine desire by end users to reduce their credit and market risk to banks. Many Lehmans counterparties and clients crystallised substantial losses from the firm's collapse, while those firms who had ensured their derivatives portfolios were routed via CCPs were immunised from such risks. These changes are having a profound impact on the market both to Banks, who are being required to adapt their business model to link in with CCPs, and also to end users of derivatives who are examining the various solutions being proposed by Banks / CCPs and how these should be implemented before the 2012 deadline.

What are we in Catalyst doing about this?

We have set up a CCP Practice in Catalyst that will be resourced by a combination of CCP specialists and experienced consultants with knowledge of derivatives end to end processing. The Catalyst CCP Practice centres around the following propositions:

1. New OTC CCPs

Part of the demand to clear OTC derivatives will be met by new CCPs or existing exchanges / clearing houses expanding to offer OTC services. CCPs should be seeking to extend the range of products eligible for clearing in order to facilitate the demand from regional banks. There is a huge range of challenges covering governance, methodology, systems, operations and default management.

Catalyst has unparalleled expertise and experience in the end to end activities of a CCP including unique insights into risk methodologies and default management. 

Catalyst provides a full range of services, from advice on how a CCP should be structured, operated and risk managed to implementation skills and project management. 

2. Client Clearing

Other demand will be met by Banks themselves providing Clearing services, by acting as intermediaries between their clients and CCPs. Banks need to offer attractive solutions to those clients who either desire CCP protection or who will be adversely impacted by the new regulations. Banks may seek to protect their existing client franchise or seize the opportunity to offer a superior Client Clearing solution.

Catalyst has resource that designed and implemented the first and, to date, only OTC CCP Client Clearing solution. Accordingly we can provide unique expert support in negotiating change both with respect to specific Client Clearing solutions (e.g. SwapClear Client Clearing) and also the integration challenges involved with providing a more complete solution to clients. For many Banks this will entail considerable reshaping of their business including setting up new Derivatives Clearing services. Catalyst will provide advice and resource to Banks as well as potentially to their clients on the implications and implementation of Client Clearing solutions.

3. OTC / SwapClear Onboarding

Interest rate swaps are generally the largest element of many Bank’s derivatives activities. For most banks the premier CCP is LCH Clearnet’s SwapClear who provides global clearing services for interest rate swaps. Onboarding to SwapClear has quite onerous implementation challenges. Catalyst has highly specialised knowledge of all aspects of OTC CCPs including risk / default management and operational flow and has direct experience of previous implementations. This knowledge and experience is coupled with a track record in delivering complex technology and operations change programmes. This means that we are uniquely equipped to assist Banks with efficient and speedy implementation which will not only result in material capital savings but also bring operational, trading, risk and collateral benefits to client Banks. Our services range from providing advice on how to ensure effective and efficient implementation to providing project management and specialist business analyst resources. The target market is the remaining 15 or so Banks that are eligible and have not yet joined SwapClear.

Similar offerings will be available for other product types such as Foreign Exchange where Catalyst is directly involved in the development of the first global OTC FX solution.

What should financial institutions be doing?

Clearly the implications of these changes have a considerable impact on all users of derivatives contracts. In addition the prospect of changes to capital requirements means that the preparation for changes should already be underway or, at the very least, being considered now. Banks and other Financial Institutions (e.g. clients of Banks) who do not currently have their proprietary derivatives portfolios in clearing need to formulate a strategy on how to optimise their capital relief. Choices will need to be made on which asset classes, which legal entities and which CCP solutions are appropriate for their institutions. Catalyst can provide unique assistance with the formulation and execution of this strategy.

contact@catalyst.co.uk
+44 (0)870 901 4155 

Created on 8 June 2010