One way to tell which topics are “trending up” on the conference circuit is the attendance at the various panels. Aside from the “big ones” – keynote addresses and exchange leader panels, for instance – the one garnering the most attention at this year’s FIA Boca conference was the clearing panel, and for good reason. Central counterparty clearing is the key ingredient of the new global regulatory regime, but this cake is half-baked at this point. Plus, some would say the recipe is in need of a few tweaks.
Here is a quick snapshot of the clearing heads’ collective views on the hottest topic of 2015.
It began with a discussion of the effects of Basel III, which Eurex Clearing’s CEO Thomas Book said had brought about “an irrevocable transformation of the business model.”
He said there were questions about what will be the direct access model for clearing houses in the future.
“There are ways CCPs can help mitigate the problems and a lot of work to be done to craft the rules to keep the clearing and brokerage firms attractive to intermediaries,” Book said.
The panel agreed that there is currently a need for more efficiency in clearing, and that there is a lack of understanding of the risk involved and of the complexity and nuances of clearing.
“Implementation of Basel III is very complex – for example, in matters related to committed liquidity,” said John Fennell, executive vp of risk management at the OCC. “Banks are having to carry too much on their balance sheets.”
“Some of the things Basel got wrong are really wrong, said Tom Hammond, the CEO of ICE Clear US. “It’s pushing market participants away. Everyone acknowledges the problem but I’m not seeing them take steps to fix it. These rules are onboarding very quickly, and clearing capability at our banks is diminished.”
Murray Pozmanter, head of clearing agency services at DTCC, said the DTCC is very focused on how to restore some of that diminished capacity in the cash markets in particular. “It’s all driving toward creating capital efficiencies,” he said.
“Skin in the game” was a topic on the panel, as it has been at the conference in general. The term refers to the amount of capital the exchanges have set aside for their clearing members in the case of a clearing firm’s default.
The moderator defined skin in the game as “CCPs’ contributions to the waterfall,” and compared it to hedge fund managers who put up a chunk of their own capital to funds they manage. (Although, at the post-panel luncheon, an exchange executive who shall not be named told us he told the moderator that was an unfair analogy as, with the hedge fund example, the manager’s fortunes rise and fall with the investors, whereas in a “waterfall” structure, in the event of a default, the exchange becomes the first line of defense).
Book said that while “skin in the game” might be a popular obsession right now, “we must look at it holistically, in the larger context. Also, he said, “there are already functioning waterfalls.”
“From Europe’s perspective, this is already implemented and done,” he said. He added,
“In Europe, skin in the game is tied to capital, but in the US I’m not aware of any specific regulation that defines “skin in the game.”
Sunhil Cutinho, the president of CME Clearing, said he disagreed with the moderator’s definition of “skin in the game.”
“Margin is also skin in the game,” he said. “From a clearing firm perspective, you bring your own clients and your own portfolios, so what contribution does a clearing firm put in a waterfall as a function of skin in the game?”
He said margin models will change – “They must evolve as you add new products and risk factors.”
The organizations are also launching new products to address various clearing concerns. CME Clearing plans to offer multilateral netting and will launch a futures contract on the repo index they announced earlier, Cutinho said. They are also working on swaptions.
Fennell said that at the OCC “our incentive is all about risk mitigation rather than skin in the game. Skin in the game is not a necessary feature if you can manage risk through good corporate governance.”
But clearinghouses do need to have sufficient capital – and the OCC has just raised its capital to 250 million, he said.
“Skin in the game is an important tool, but it’s just one tool,” Pozmanter said.