New Clearing Rules Vex Buyside Firms

With the passage of Dodd-Frank and other regulatory mandates, buyside firms have to focus on the clearing of over-the-counter derivatives. Combined with Dodd-Frank in the U.S. and Basel III and the European Markets Infrastructure Regulation in Europe, the challenges of clearing these trades are more complex than ever.

Both Dodd-Frank Title VII and EMIR mandate that OTC contracts need to be cleared centrally for the vast majority of participants. According to Steve Grob, director of group strategy for Fidessa, the move from bilateral to centralized clearing creates a number of challenges for the buyside. First of these is that centralized clearing requires upfront margining, which places additional pressures on a firms collateral. Ironically, that pressure on collateral may mean that some reduce their use of derivatives which, in their purest form, are a great way of hedging risk, he told Traders.

Second is that buysiders may choose to trade contracts that are cleared through one particular clearinghouse rather than another, so as to benefit from margin offsets against long and short positions of similar contracts. Having a clear view of this at trade time is a particular challenge. Finally, buysides need to participate in a credit checking process so that they know that they have sufficient credit with any particular CCP, he added.

For buyside firms, going it alone is no longer an option. Buyside firms will need to have a relationship with an FCM (futures commission merchant) or other party in order to participate in the centralized clearing process. Doing it themselves is simply not an option under the rules, Grob said.

He continued, Those firms that trade swaps will ultimately care about the clearing dynamic because it will affect the contract they select. Greater clearing efficiency on one contract may outweigh a better price on another.

While U.S. trading firms have been dealing with Dodd-Frank for more than two years, new regulations from Europe, namely EMIR and Basel III, will have an impact on American traders who deal overseas. The whole issue of extraterritoriality has up to now extended primarily from U.S. regulatory authorities outwards into Europe and Asia. The rules in Europe are yet to be finalized but will doubtless have an impact on U.S. traders who wish to trade in international markets, Grob said.

In conversations with clients, Grob said, he hears concerns about collateral management and the need to move collateral between different funds to manage margin requirements. Another issue is deciding when to use a swap or a future, he added. The swap will provide greater precision in terms of matching the hedging risk, but is more expensive from a margin point of view. For some of the very large, risk-averse buyside clients that have historically traded bilaterally with other similar-size and equally risk-averse buysides, there is an argument that forcing them to use a CCP (central counterparty) is actually increasing rather than decreasing their risk, he told Traders.