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More Diverse Participants Should Use Central Clearing

Traders Magazine Online News, December 14, 2018

Shanny Basar

Clearing houses should offer opportunities for netting offsets to increase the number of over-the-counter participants in central clearing and improve market quality according to Joanna Cound, head of global public policy, Europe, Middle East and Africa at BlackRock.

Cound is also a board member of the Asset Management and Investors Council, which represents the buy side, in the International Capital Market Association. She wrote an article on central clearing in the AMIC annual review and reiterated that BlackRock is supportive of central clearing.

She said in the review: "The reduction in bilateral counterparty credit risk, increased market transparency, together with the improved efficiency in trade execution outweigh the significant operational costs incurred by market participants and end- investors to comply with clearing mandates."

However, she also warned that the current market structure was not fully designed to handle the diverse set of clients or the range of market risks inherent in over-the-counter products. Cound continued that regulators and the industry should try to bring a greater number of OTC participants into clearing and to evolve clearing models.

“While central clearing of OTC derivatives as a concept and market practice matures, the framework to incentivise clearing through resilient CCPs, that protect the interests of all stakeholders in times of stress, is still a work in progress,” she added. “Indeed, the recent losses incurred in the Nordic power markets revealed that CCPs are not immune to market disruptions.”

In September there was a default at Nasdaq Clearing in the power market when a Norwegian trader, who cleared his own trades, could not meet the required margin calls and was declared in default.

Clarus Financial Technology, the derivatives analytics provider, said in a blog Nasdaq had a total default fund of €166m ($188m) and cost of closing the relevant positions was €114m. This cost was covered by clearing member contributions of €107m and €7m from Nasdaq. The CCP then asked members for €100m to replenish the default fund.

Amir Khwaja, chief executive of Clarus, said in the blog: “Of course those who lost a large chunk of their contributions will ask why the initial margin and default fund contribution of the defaulting party was not sufficient to cover the loss. But that can be a double-edged sword, as most members would not want initial margin to be so high as to never require the use of a default fund, that would make clearing more expensive for all.”

Cound added: “The importance of continued regulatory focus was emphasized by the large mutualised loss experienced in the Nordic power markets earlier this year, with two-thirds of a CCP’s default fund consumed by one single clearing member default. While the CCP proved resilient, the loss allocation defied expectations and should challenge assumptions.”

To protect the end-investor from bearing losses due to the failure of CCPs, Cound said Blackrock objected to the use of variation margin gains haircutting and requested that regulators formally limit its application.

She continued that having more participants using central clearing improves market quality as there is more liquidity when trading in and out of a position. To increase the number of OTC participants in central clearing and to evolve the clearing models Blackrock recommends that CCPs should offer opportunities for netting offsets.

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