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August 25, 2015

Derivatives Clearing; it’s not the beginning of the end, it’s the end of the beginning!

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” ― Winston S. Churchill, Their Finest Hour

Derivatives Clearing; it’s not the beginning of the end, it’s the end of the beginning!

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

Winston S. Churchill, Their Finest Hour

Clearing through a central counterparty (CCP) has increased the emphasis on real-time processing and STP of trade lifecycle processes, along with fully integrated data management and workflows.  The basic building blocks of client's clearing operations and technology infrastructure have already undergone considerable change and enhancement.

The core challenges now facing the entire industry are common to all participants. The foremost being ‘how do I futureproof my clearing infrastructure to accommodate the raft of market and regulatory driven changes still to come?” 

Whether it’s new products from CCPs or clearing brokers, industry initiatives and collaborations, innovative Fintech solutions, software upgrades or the next wave of regulatory requirements, all of these will have an impact on your clearing infrastructure. The difficulty is knowing what to tackle first and how the decisions you make now will affect your ability to accommodate possible future changes.

In the face of all of this change the question we hear most often is “where do I start?”. Everyone has asked this question at one stage or another, not only the late adopters but those with already established infrastructures.

The basic building blocks of an efficient clearing infrastructure

Whichever way you look at it, even the basic building blocks represent a significant change to your operating costs, whether it is technology or headcount driven. Leveraging off your clearing broker’s suite of services allows you and your organisation to maximise its operational efficiency and thereby keep the costs and resource pressures as light as possible

But what about your resourcing decisions? You can either deploy existing resources alongside existing functions, or restructure to ensure resources are dedicated to the core functions of trade flow management, margin, collateral and cash management.  A further option that shouldn’t be overlooked is full or partial outsourcing of key functions; a topic we will explore in more depth in a subsequent article.  You also need to consider staffing and holiday coverage in light of the requirement for operational support in line with CCP holiday schedules (or operational buffers).

Encouragingly there are numerous efficiencies realised as part of even the most basic clearing infrastructure when compared to the existing bilateral architectures. These are mostly due to consolidation and centralisation of activities through your clearing broker(s), from legal documentation, to market connectivity, to cashflows.

What is clear is that beyond the basic building blocks of the clearing infrastructure the overall post-trade process is becoming increasingly complex and demanding. Consequently it is increasingly important that your clearing infrastructure be both flexible and adaptable.

Most, if not all of the decisions taken by businesses today will impact the efficiency and the cost of clearing infrastructure.   The degree to which these provide future proofing against the onset of market driven and regulatory changes is also important to consider.

The key market driven initiatives

Despite the extent of the challenge facing market participants, there are a host of new solutions, innovations and key market driven initiatives to consider, when doing any cost benefit analysis or infrastructure future state analysis.

In a recent survey by Euroclear, Collateral management was highlighted as a key priority for participants. The survey[1] found that about 85% of European companies say collateral management will be the top or a high priority during the next two years.  Moreover the focus on collateral management has caused many firms to ‘relocate’ a once back office function to front office, emphasising the importance of collateral efficiency in the new paradigm.

As such it is no surprise that a large number of market initiatives and Fintech solutions are focussing on collateral management, collateral velocity, asset optimisations, and GC liquidity or improving the efficiency of different aspects of the margining process.  A number of initiatives have emerged to answer the liquidity squeeze that has developed in the credit markets. Examples include new buy side solutions for liquidity, as well as the drive towards a standardisation of margin and collateral processes and messaging standards.

The clearing houses are also announcing their own product developments, in and around CCP margin and collateral management. These look at both liquidity solutions and ways to enable client and clearing members to benefit from cost savings from a capital charge and processing perspective.

Commerzbank itself responded to challenges facing market participants and developed TradeCycle an innovative post-trade offering. Whether the focus is on cost efficiency, risk management, improved return on assets or regulatory control, TradeCycle provides a one-stop-shop for post-trade services to suit clients’ individual requirements. Our collateral solutions services are built to help clients reduce costs and streamline their operations.  Solutions are individually tailored to clients’ needs and are available on a bespoke and modular basis, thereby achieving the optimal balance of insourced and outsourced capabilities from a cost and efficiency perspective.

It is a fast paced, changing landscape, in which collateral management solutions will continue to evolve.  What is next, the application of Blockchain technology to address collateral traceability in the event of default and make portability of collateral less cumbersome?  Who knows what the future holds.

The key regulatory ‘known unknowns’

Finally, businesses need to be aware of changing regulations and the potential implications.  The EMIR clearing mandate is not the end, in some ways it is only the beginning. Most, if not all organisations will continue to face operational and technical challenges to evolve their infrastructure and keep pace with the regulatory change in a timely and cost efficient way. No one wants to have to throw away what they have and start again because of a lack of foresight when original or initial decisions were taken.  This is obviously easier said than done but not impossible.

Summary of OTC business functions impacted by regulatory requirements

What is most often overlooked in the context of clearing infrastructure planning is the next wave of regulation. MiFID II, an important example, addresses the mandate for execution on electronic trading venues, clearing latency (the time limit within which trades will need to be accepted for clearing by clearing brokers and CCPs alike),  and clearing certainty. These rules could potentially turn the trade workflow and lifecycle on its head with clearing acceptance confirmed at the point of execution.

Primarily there will be an impact on connectivity interfaces and data management with the requirement to gain access to OTF/MTF platforms, direct or via execution or a clearing broker. It is important therefore, to look ahead and not only consider this in infrastructure decisions now. Businesses need to understand how to adapt to the coming changes, to make sure they consider this when choosing relationships and providers now.

Additionally, trade reporting will continue to evolve with enhancements and new requirements –  including support for new data elements, reference data and identifiers (trade), product type, entity, event, and collateral portfolio code to name but a few.

In conclusion, it is evident that basic clearing infrastructure is relatively straight forward to implement and brings with it inbuilt operating efficiencies.  However, there are a raft of options available that can deliver richer functionality as well as the opportunity for cost savings and efficiencies.

The journey is not over, your infrastructure road map may be in its infancy or not even delivered, but in 2016 and into 2017 there is likely to be an even more pervasive change both from an execution and clearing lifecycle perspective (see below diagram for an indication of the changes to come). It remains critical you plan now to avoid a bumpy road ahead.

Future-proof your infrastructure by expanding integration of services beyond OTC Clearing


[1] Euroclear published a report produced by Aite Group entitled “Collateral Management in Europe: Searching for Central Intelligence” on 19th May 2015 at its 14th annual Collateral Conference in Brussels, Belgium.


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