New Startup Will Replace Central Clearing and Rewrite Global Regulation on Margin
A new startup plans to replace CCPs which have become "too big to fail". Their website says:
Decentralised clearing - Disrupting the CCP model
Ever since the financial crisis, regulators have been pushing central clearing to remove counterparty risk and reduce systemic risk. However, as a higher proportion of swaps is cleared through CCPs, clearing houses are concentrating risk on their own balance sheet. Synswap disrupts this central clearing model and uses blockchain technology to disintermediate CCPs. Decentralised clearing retains all the benefits from central clearing - reduction of counterparty risk exposure, multilateral netting, price transparency - while removing both concentration and counterparty risk from CCPs.
One of the co-founders of the business explained:
We agree that clearing is necessary for OTC derivatives in order to reduce counterparty and systemic risk, however we believe that concentrating counterparty risk within a single point of failure defeats the whole purpose of CCPs. CCPs have become systemically important and are now clearing more complex, less liquid instruments which increases their risk. CCPs have thus become too big too fail and bailing out a CCP is not better than bailing out a financial institution as [it was] during the financial crisis.
To bypass the negative effects of risk centralization while keeping the benefits of clearing, Synswap replaces the centralized clearing model by a distributed clearing solution. Trades cleared via Synswap benefit from the same risk mitigation mechanisms as CCPs, ie multilateral netting, margining, compression and member’s default management. However, contrary to the current clearing model, Synswap leverages the blockchain technology, meaning that every member of the platform enrolls in the network as equal members, supporting and executing the clearing workflow in this peer-to-peer network. The use of smart contracts automates the whole post-trade workflow (of which decentralized clearing only is a part) by embedding self-executing code.
OTC Space asked some questions
1. You will be creating a platform that provides all the same protections as a CCP?
Yes, for cleared trades. Synswap also handles uncleared trades processing.
2. This will include novating trades to face your firm as the central counterparty?
No, there is no central counterparty in our distributed clearing model. Our firm is not a counterparty in any of the trades processed through Synswap; we provide the technology needed to implement this distributed clearing network among the members. Members themselves will be running and executing smart contracts to process and clear trades.
The platform we are developing is able to manage the post-trade workflow of bilateral and cleared trades. Cleared trades will remain bilateral trades (in the sense that there won’t be a central counterparty stepping in the middle of the trade) but will undergo the same risk mitigation mechanisms as centrally cleared trades, reducing systemic and counterparty risk.
By removing CCPs from this clearing model, we allow cleared trades to have exactly the same benefits provided by CCPs and we remove the concentration and counterparty risk of CCPs.
3 You will apply for regulatory approval in all relevant jurisdictions to become a recognised CCP?
We should not be considered as a CCP as we are not a clearing house and we are not a counterparty either. We are providers of technology. Even though we only provide technology, we may however have to be regulated in all relevant jurisdictions.
The OTC Space recently published an article about the ISDA latest whitepaper (“The Future of Derivatives Processing and Market Infrastructure”) in which the ISDA is asking the industry to develop solutions to post-trade inefficiencies and promoting standardization, automation and innovation. Synswap exactly responds to those needs: our technology automates derivatives processing for bilateral and cleared trades, increases efficiency, reduces operational costs and simplifies the post-trade workflow.
4. How will you cope with the existing regulation requiring clearing and margining?
We are aware that before any implementation of our system, we need to work together with regulators as moving from a central clearing model to a distributed clearing model involves a change in the regulation. It will take time and reshaping the OTC market infrastructure is not a short-term project, however regulators are discussing blockchain technology and seem to be supportive of this technology. This is why we are confident that we will get regulatory approvals, even though it may take some time.
Please note that we are still in the development phase and will go through testing and regulatory approval phases before launching.