status – CENTRAL COUNTERPARTY CLEARING
Prepared for any eventuality
Managing risks arising from securities, currencies, commodities or forward transactions by clearing such trades via a central counterparty (CCP) will become more and more important, especially as CCP clearing can include many different financial products. By turning to a CCP, market participants can reduce their credit risks vis-à-vis other parties, while at the same time leveraging portfolio and netting effects to push their financing and capital costs down, thereby increasing profitability. To expand these efficiency gains, Eurex Clearing has redefined access to the clearing house and extended its product range.
OTC derivatives are contracts that are traded directly between two parties, without involving an exchange (such as Xetra® or Eurex®) as an intermediary. Today, products such as swaps, OTC forward transactions, “exotic” options – and other “exotic” derivatives – are traded almost exclusively in this way. OTC derivatives is the world’s largest derivatives market segment.
Once an OTC transaction has been concluded on a bilateral basis, these transactions are forwarded to a clearing house for centralised netting and risk management purposes. The clearing process of OTC transactions in the CCP is nearly identical with the clearing of exchange-traded derivatives. The difference lies in the degree of standardisation of the products, and the resulting complexity associated with measuring risk.
Clearing is becoming more direct: ISA Direct
Up to now, clearing members at Eurex Clearing, one of the clearing houses of Deutsche Börse Group, consisted primarily of banks. Investment funds, pension funds or insurance companies, generally referred to as the buy side, had only indirect CCP access. Within such a structure, the buy side remains exposed to the credit risk of the direct clearing participant, and must bear significantly higher costs now than a couple of years ago, when capital requirements for clearing banks were more favourable.
Since summer 2016, a new service has been available for buy-side clients who become direct participants with Eurex Clearing. Under the new regime, certain services that these clients so far have received from their clearing bank remain with the clearing bank. One of the main benefits of the new structure is that the buy-side client can significantly reduce their counterparty risk. In addition, the model allows the clearing bank to substantially cut down on capital costs, supporting return on capital invested – even when reducing service fees for the buy side.
This access model is currently available for OTC (over-the-counter) interest rate swaps as well as repo transactions (agreements on buying and buying back securities), and is planned to be expanded to include securities lending and exchange-traded derivatives transactions. Further efficiency increases can be realised where a buy-side client uses more than one offering, especially with regard to the use of securities collateral offered by Eurex Clearing and Clearstream.
The new offer is called “ISA Direct” (ISA = individual segregated account). ISA Direct is aimed at small and medium-sized credit institutions, insurance and reinsurance companies, pension funds and investment funds. Apart from the advantages mentioned above, clients benefit from a more stable clearing house and, as a consequence, a more stable financial system – since concentration of the clearing business upon only a small number of clearing banks (as is the case at present) is dissolved. On the flip side, in case of an emergency – if a clearing bank fails to meet its obligations – the size of the portfolios to be settled becomes smaller, and the systemic risks in the clearing house are thus reduced. The more buy-side clients opt for direct CCP access, the better for Eurex Clearing participants and the entire financial market.
Centralised clearing of securities lending transactions
The mostly bilateral OTC transactions, e.g. between two banks, continue to account for the lion’s share of the securities lending market. Such OTC transactions are generally concluded for a longer period of time, and there are credit default risks that may threaten the performance in case of one party defaulting.
By clearing transactions, a central counterparty minimises counterparty risk – both in exchange trading and OTC. The CCP nets positions, reviews, continuously determines the risk associated with any given business portfolio, and requests collateral from its clearing participants. In other words, the clearing participants associated with the CCP are protected on a daily basis, and no bilateral (and non-transparent) risks accrue (see diagramme “Effect of a counterparty default in a non-centrally and centrally cleared market”). The risks converge instead in the CCP, where they are netted and risk-adequately hedged.
Effect of a counterparty default in a non-centrally and centrally cleared market
Securities lending transactions
Eurex Clearing is the first CCP worldwide to also offer clearing services for securities lending transactions between investors and banks. The so-called Lending CCP enhances the security and efficiency of a market that traditionally has been defined by OTC transactions: it is important to involve a central counterparty particularly for lending transactions to hedge against changes in the credit risk profile – or even against a counterparty default. This also allows positions to be netted – so-called multilateral netting, which reduces capital employed and therefore the costs associated with a transaction.
The business customs of the securities lending market influenced the design of the Lending CCP, which also features the well-known strengths of the CCP clearing service offered by Deutsche Börse. This approach pursues the evolution of the markets, and their customs, and takes the interests of market participants into account. There are advantages not only for the individual clearing participants; the markets will become more transparent and secure in general. This represents a truly sustainable offer from Deutsche Börse Group for the financial sector.
Clearing in FX trading
“It is important to us that our clients have access to comprehensive service and product range via a single provider. With the acquisition of 360T by Deutsche Börse, we have now added foreign exchange (FX) as an additional asset class. Within the scope of our EurexOTC Clear service, we plan to also offer an OTC FX swaps, OTC FX spot and OTC FX forwards clearing facility, as from summer 2017,” said Erik Tim Müller, CEO of Eurex Clearing. “We are proud of these innovative offers, as they will provide our clients with further post-trading process and cost efficiency.”