Have you been de-boarded? Get ready to swim.
Large institutions such as pensions, long-term funds and commercial hedgers might be about to get dumped, thanks in part to Basel III and other regulatory rules that have made such low volume, but high balance sheet firms no longer viable as customers. That’s the message from executives at the World Federation of Exchanges/IOMA conference in São Paulo, Brazil.
It’s no secret that the FCM model has been broken in the extended low/no interest rate environment that used to provide a major source of revenue for futures brokers. That has forced brokers to turn to commissions and high volume traders maintain positive cash flows. Now, with capital leverage ratios for banks, large commercial hedgers and institutions that trade infrequently are getting dropped by their banks. Jan Bart de Boer, chief commercial officer at ABN Amro Clearing, said firms are now having to price risk returns of customer accounts, the price of margin given the higher margin requirements at clearinghouses, and leverage ratio requirements as well.
“The leverage ratio will have to be priced in,” de Boer said. “Funds will be served and other service clients will go away.”
John McPartland, senior policy advisor, Federal Reserve Bank of Chicago, says he has a solution that could help such customers and free up valuable capital for clearing member firms – allow large institutional players to become members of the clearing house.
Here’s how it would work. Clearing member firms currently are required to put up 10 percent of the maintenance margin. As such, some of its largest customers – pension funds, endowments, corporate pensions, insurance companies – could be allowed to become clearing members, or “commercial clearing members.” This would serve a dual purpose. With huge balance sheets off their books, clearing FCMs would lower their capital requirements. Institutional firms, in turn, would help diversify the clearing house. And certain clearing services, outside simple initial margin and variation margin, will be outsourced back to clearing member firms along with compliance requirements to their former FCM.
Meanwhile, with commercial clearing members, clearing houses can further diversify its risk and make each settlement transactions much smaller.
McPartland argues that the current capital constrained environment is forcing market participants to think about new solutions. This could be one.