Diana Chan, EuroCCP
About 30% of equity trades in Europe cleared by central counterparties (CCPs) are cleared through the single CCP mandated by the national stock exchange. But with derivatives likely to be the source of growth and equities clearing not being a major profit generator for these exchanges, they might soon conclude that offering their clients a choice of CCPs would make good business sense. Besides, regulations that compel them to open up to competitive clearing are fast approaching.
The use of CCPs to centrally manage counterparty risk in equities trading was spurred by the widespread introduction in the early 2000s of electronic order books, which remove the trading firms' ability to choose the party they transact with. By 2007, there were nearly 10 CCPs clearing equities in Europe
The second phase of CCP clearing was prompted by the EU Markets in Financial Instruments Directive (MiFID), which created the regulatory environment for new multilateral trading facilities (MTFs) to compete with the national stock exchanges. MTFs typically trade stocks listed on a number of national exchanges and use CCPs with pan-European capabilities.
Firms trading stocks in multiple markets needed to connect to different CCPs and fund collateral on separate positions. As a result, demand grew for interoperability - the ability of each firm to concentrate clearing with the CCP of its choice, settle once and fund considerably less collateral.
A provision in the Markets in Financial Instruments Regulation (MiFIR), expected to come into effect in 2017, will give CCPs the right to access trade feeds of national stock exchanges. But EuroCCP is not relying on regulation to deliver choice to customers and is advocating that all trading platforms cleared by any interoperating CCP, namely EuroCCP, LCH.Clearnet Limited and SIX x-clear, should give equal access to all three CCPs.
To deliver the full benefits of competition to trading firms, they need access to the same trading platforms. While the large MTFs have supported this, equal access to the national stock exchanges is still a work in progress. For example, it was as recently as May of last year that EuroCCP confirmed it will have access to trades executed on London Stock Exchange (LSE) which is already cleared by LCH.Clearnet Ltd and SIX x-clear. Following a short delay, EuroCCP is expected to go live clearing for the LSE in the near future.
The next priority is to ensure that all three interoperating CCPs have equal access to those trades originating from three national exchanges, NASDAQ, Six Swiss Exchange and Oslo Bors, which are cleared by one or two interoperating CCPs but not all of them. This is the 'three x three' initiative. Approximately 10% of trades originate from the three national exchanges but are not cleared by all three interoperating CCPs. So successful delivery of this initiative will mean that firms can direct over 60% of trades executed in Europe to the CCP of their choice.
A notable characteristic of the European clearing market is its fragmentation. The economics of trading firms funding nearly 10 market infrastructures contrasts very unfavourably with the enormous economies of scale delivered by the single equities CCP operating in the United States, which has nearly 10 times the trading volume. Most firms in Europe, though, favour competition and consider two or three interoperating CCPs as the optimal configuration.
The third phase of the evolution of CCP clearing is likely to be consolidation stimulated by regulation. The requirement to comply with the European Market Infrastructure Regulation (EMIR) that sets minimum safety standards for CCPs and new rules on the recovery and resolution of market infrastructures will add compliance costs to what is basically a fixed cost business.
Most national stock exchanges regard derivatives as their engine for growth and no longer expect any significant profits from equities clearing. Any collateral savings from portfolio margining equities with equity derivatives at the CCP level will be insignificant, and in any case EMIR requires the separation of margin and clearing funds for different asset classes. The exchanges' management time is probably going to be better spent on the more remunerative parts of their business. National stock exchanges might come to the conclusion that letting trading firms use their own CCP of choice brings customer goodwill and that this is well worth doing before they are obliged to do so by regulation.