Client Clearing In-depth

The Client Spectrum

O
Overview
i
Who is impacted
p
by
y clearing
g mandates and what are
the relevant timelines?
What is the scope of products impacted by clearing
mandates?
Incentives and common concerns related to clearing,
including commercial and risk considerations
Overview of decisions, documentation and
implementation
How will capital rules impact me?
Extraterritoriality concerns for clients
2

Concerns
Cost
New post trade costs
Variability between Clearing Brokers
Segregation
Risk of the clearing broker defaulting and
the clients collateral being lost
Service Continuity
Current OTC derivative is a contract
between two parties. When the same
transaction moves to clearing the
Clearing Broker will provide a service,
which they can resign from
Collateral availability
Variation Margin to be paid in local cash
Initial Margin to be paid in high quality
government
go
e
e t bo
bonds
ds

Current Bi-Lateral
Execution

EB 1
EB 2

Client

EB 3
EB 4
EB 5

OTC Clearing
Client

CM

CCP

Incentives

M
Mandatory
d t
U.S. mandated USD, EUR, GBP to 50yrs and
JPY to 30yrs
EMIR mandate expected in Q2-Q3 2015
Risk Reduction
Reduced systemic risk between counterparties
Independent third party marking positions and
assessing risk
Collateral segregated from clearing brokers
Portability between clearing brokers
Operational
Consolidated reporting
Consolidated collateral, coupon, upfront
payment and interest payments
Simplified
Si lifi d operational
ti
l process
Capital
Client can face CCP for capital purposes
Brokers have reduced capital requirements for
cleared derivatives
Liquidity
Potential liquidity shift to cleared OTC rather
than bi-lateral

Current Bi-Lateral
Execution

EB 1
EB 2

Client

EB 3
EB 4
EB 5

OTC Clearing
Client

CM CB

CCP

Standard
Documentation

NEGOTIATED POINTS
Trading Limit
Structure

Maximum Initial Margin Limit

Daily / Liquidity Limit

Pre-Funding

Initial Margin

Credit multipliers

Eli ibilit criteria

Eligibility
it i

Triggers

C ll t l
Collateral

Transfer mechanics

Core Agreements
US: FIA/ISDA Addendum
EU: ISDA Clearing Annex
EU: Modified Credit
Support Annex
plus
Futures and Options
Agreement or baseline
agreementt
Segregation/Portability
Docs

Variation Margin

Termination or change
of Service

Timings
Single currency margining

Termination Period

Action during resignation period

Margin Level/Collateral eligibility

Terms under which margin is changed

Change Limits
Adjust eligible products

Trade acceptance
p

Account structure

Default

Guaranteed acceptance

Terms for acceptance

Trades by Trade basis

Reasons for acceptance suspension

Omnibus Segregation
Individual Segregation

LSOC in
US

What constitutes a default / ATE

Interest Charges/Credits

Resolution/Cure period

Ticket Fee

Close out/course of action

Risk Maintenance Fee

Clearing Fees

Fee structure

House Fees

Minimum Fees

Global Regulatory
g
y Update:
p
US ahead of Europe, and CFTC leads SEC in rulemaking

Although US and European regulations have similar

objectives
bj ti
((reduce
d
counterparty
t
t risk,
i k iincrease oversight
i ht
and competitiveness), they differ in scope, approach and
timing.
Generally
Generally, European regulatory initiatives are proceeding at a
slower pace, attributable to the many individual country regulators
involved in the process.

In the US,, regulatory

g
y responsibility
p
y for the swap
p market is
divided between the CFTC, which is responsible for
regulating CDS indices and interest rate swaps, and the
SEC, which is responsible for regulating single name CDS
and
d equity
it swaps.
The CFTC is much further along in the implementation process
and as such, our discussion within the US will primarily focus on
the status of regulation as it pertains to the CFTC.
6

Important Recent Developments:

Trading Venues in the US; Trade Reporting in Europe

In the US, the most important recent developments have focused on

the implementation of the Swap Execution Facility requirements
requirements.
In October, the first Made Available to Trade determinations were filed with
CFTC by SEFs.
CFTC can approve these determinations which means that market
participants must begin SEF trading 30 days thereafter.
thereafter

In Europe, the most important recent development is the

commencement of the trade reporting requirement
ESMA authorized 4 trade repositories on Nov 7.
From February 12, 2014, all counterparties established in the EU must report
details of their transactions to a trade repository by the next working day
following the conclusion, modification, or termination of the relevant contract.
Counterparties will need to agree between themselves whether to report
separately, to agree that one will report on behalf of both counterparties, or to
delegate the reporting obligations to a third party.

Status of Clearing Mandates:

Client clearing in the US has commenced but EU requirements are still being developed

Mandatory clearing is under way in the US, but

mandatory client clearing in Europe (for both indices
and single-names) is not likely until Q3 2014
European clearing on a voluntary basis has started recently.

Exchange trading under MiFID/R in Europe is not

expected until the end of 2015 at the earliest but
but, in
the US, exchange trading under SEFs will begin
soon.
The potential for regulatory mismatch has caused
some uncertainty in the market.
8

M k tP
Market
Participants
ti i t
Clearinghouses: CME, ICE, LCH
Middleware: MarkitWire (Markit Trade Manager),
ICELink, TradeWeb, CME Clearport, Bloomberg
VCON
SEFs: Creditex, BCG, Tullett, Phoenix, GFI, ICAP,
T d
Tradeweb,
b M
MarketAxess,
k tA
Bloomberg,
Bl
b
T
Tradition,
diti
Javelin, TrueEx
FCMs: BAML,
BAML Barcs
Barcs, BNP
BNP, Citi
Citi, CS,
CS DB,
DB GS,
GS JPM,
JPM
MS, RBS, UBS
26 ((or so)) active dealers
9

O
Operational
ti l IIssues
Biggest concern for FCMs is middleware connectivity.
Rates - Bloomberg VCON & MarkitWire
Credit - Bloomberg VCON, Clearport, ICE Link, MarkitWire
FCMs cited incorrect trade mapping and lack of
responsiveness, particularly in interest rate clearing, as the
number one concern
concern.

Collateral models for customers:

Gross omnibus
LSOC with excess
LSOC without excess
10

Cl i Advantages
Clearing
Ad t
Bilateral derivatives will be subject
j
to increased capital
p
charges including a higher RWA for uncleared as
compared to cleared swaps, and possible CVA charges if
any uncollateralized
ll
li d exposures are allowed
ll
db
by the
h b
bank.
k
Regulators have provided incentives for buy-side
participants to use central clearing
Opportunities for cross-product margining
Favorable margin methodology for cleared products:
1 to 2-day, 95% VaR (futures)
5 to 7-day, 95-98% VaR (cleared swaps)

Uncleared swaps will be subject to 10-day

10 day, 99% VaR
VaR.
11

Cl i h
Clearinghouse
Fees
F
Each clearinghouse will charge its members fees:
annual clearing fees
booking
g fees
maintenance fees

Additional costs may be incurred for technology

licensing and operational connectivity.

12

FCM Fees
F
FCMs typically agree on a fee schedule or standard
charges for customers to act as their agent for
clearing.
Primarily this is in the form of ticket charges per trade and
bps
p charged
g on IM ((an approximate
pp
measure of balance
sheet utilization and risk).
Charges can also include allocations for default-fund
contributions owed by the FCMs to the various
clearinghouses.
clearinghouses
Customers can assume that default fund fees are passed
from FCMs onto their clients either directly or indirectly.

13

C
Cumulative
l ti Effect
Eff t off Clearing
Cl i
According
g to a recent study
y by
y Sapient
p
Global
Markets, the costs of hedging duration in a postDodd-Frank environment will increase.
Sapient estimates that the drag on portfolio alpha in
the new environment will range from between ~20bps
to ~62bps for cleared trades, depending on the
product,
d t and
d up tto ~91bps
91b ffor ttraditional
diti
l uncleared
l
d
bilateral OTC trades.
In short,
short hedging using cleared instruments (either
swap futures and cleared swaps) will be preferable in
most if not all cases.
14

E ti t d IImpactt on Returns
Estimated
R t

Source: The Cost of Clearing:

g A Buy-side
y
Investigation, Sapient Global Markets, June 2013.

15