July 2009

BACK OFFICE VIEW: Vindication for centralised clearing

CCPs have stood strong in the middle of all trades providing the comfort that counterparties and regulators desire. Marco Strimer (pictured) of SIX x-clear comments... marco_strimer.jpgAgainst a backdrop of unprecedented volatility and amid some of the most complex and turbulent trading conditions seen for years, the world of clearing and settlement was cast centre stage following the failure of Lehman Brothers. The successful transfer of trades following the bank’s historic collapse in September 2008 overcame a major hurdle in the clean-up operation and marked the clearing and settlement operations that underpin many markets as one of the few success stories of the year.  Long regarded as the ‘plumbing’ of the industry, it validated and vindicated the centralised clearing model.

Clearing houses, or central counterparties (CCPs), are a key component of the post-trade infrastructure – standing between parties to a trade in case of default. A CCP acts as the insurance agent against the threat of a default like Lehmans. They act as a buyer to every seller and a seller to every buyer in a transaction.

Following the Markets in Financial Instruments Directive (MiFID) reforms of 2007, new trading venues – the so called multi-lateral trading platforms (MTFs) such as Chi-X and Turquoise – emerged to challenge the hegemony enjoyed by market stalwarts like the London Stock Exchange (LSE). In an interesting parallel, CCPs, such as SIX x-clear, also pushed forward to encourage competition and foster interoperability across the CCP market structure. The development of both MTFs and interoperability amongst CCPs are rooted in one key issue – competition.

If we talk about competition in the world of clearing, the interoperability debate never lies far behind. Interoperability is an agreement between CCPs and exchanges allowing their customers to have trades cleared across either CCP platform. This concept has the full support of the EC and the Brussels-brokered 2006 Code of Conduct has asked the industry to allow greater choice in where trades may be cleared. Nonetheless, progress has often been slow. 

SIX x-clear is a fierce proponent of interoperability and believes that it genuinely benefits customers – providing the choice and efficiencies increasingly needed to navigate the fragmented trading landscape. We are staunch in our support because we know that it works.

The Code of Conduct had its first success on these shores in December 2008 when the LSE allowed its clients a choice of CCP provider and SIX x-clear joined LCH Clearnet as the exchange embraced interoperability. UBS, the largest single provider of trading liquidity on the LSE, immediately moved all UK equities to SIX x-clear, allowing the bank to combine its UK flow at one clearer and thereby drive down the unit cost of clearing. 

UBS’s implementation highlights the worth of the dual CCP model – namely the ability to pass cost and operational benefits on to clients.  Interoperability is not a dirty word; if an institution wishes to stay with the incumbent clearer it can, and if it wishes to switch clearers it can also do so without issue. Very little is heard once an institution decides to change provider and in the world of clearing, silence means that all trades are being properly cleared.

Although the march towards interoperability has been a protracted affair, the industry is certainly moving in the right direction and since the LSE’s decision we have seen Chi-X, Turquoise, BATS Trading and NYSE Arca Europe all proclaim the merits of a competitive clearing system. This is good news for the market, as clearing choice in the form of a ‘one stop shop’ for customers is a way of reducing costs by allowing more efficient cross netting over a number of execution venues on which the same stocks are traded.

CCPs have stood strong in the middle of all trades providing the comfort that counterparties and regulators desire. It is now recognised that although lower prices are important, efficient and effective risk management is much more so. If there is one function in which a CCP must have expertise in, it is risk management – and understandably in current market conditions it is vital that risk is calculated in real-time. With the need for effective risk management and lower costs it can be seen that interoperability works and is here to stay.

• Marco Strimer is the CEO of SIX x-clear

©2009 funds europe

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