In the European market the relationships between exchanges and CCPs are currently driven by commercial decisions, with MiFID 2, this is supposed to change.

In the European market the relationships between exchanges and CCPs are currently driven by commercial decisions, with MiFID 2, this is supposed to change.

In the market now are arrangements called “interoperability” which means CCPs facing each other directly in this model. See Figure 1.

Users of the exchange can individually choose which CCP to clear their trades at, and the CCPs cooperate by holding trades between each other representing the pass-through relationship.  Under MiFID 2, this isn’t true Open Access, even though it gives CCP users a choice.

What the regulators envisage is the right for an exchange to choose where it sends trades to be cleared, and for a clearing house to choose which exchanges it clears for.  In other words enabling a many to many relationship to occur between CCPs and Exchanges, something which doesn’t really happen now. See Figure 2.

The regulators would like to see the opportunity for a CCP to clear for multiple exchanges and provide margin offsets between both sources of trades. MiFID 2 gives a CCP the right to request access to any European exchange to clear business. See Figure 3.

Regulators would also like to see an exchange have the right to request access to clear at any European CCP, giving users the choice of clearing house.

Users Have the Power

Lets imagine the behaviour of the trading and clearing members of the exchanges and CCPs and pretend in Figure 3 they can choose which CCP to clear at.  If they decided en-masse to route all their business to one CCP, they would achieve maximum risk offsets and lowest fees based on volume. But, given that a move by all users to a single CCP in Europe is unlikely, they will continue to support more than one CCP in this scenario.  This would mean each time they trade, having to indicate which CCP the trade should be routed to, and if their counterparty isn’t a member of their preferred CCP, not trading with them.

An Exchange (in Figure 3) will need to support two pools of liquidity, one for each CCP, where pairs of firms trade with the intention of clearing at a specific CCP. This has already occurred on SEFs in the US, where the prices for OTC trades are quoted specific to the CCP intended to clear the trade.

The Right to Refuse

Built in to MiFID 2 are rights for the regulator of an exchange to refuse an access request if:

• The link would fragment liquidity
• The link would adversely affect systemic risk
• The link would require the interoperability approach (above) unless all parties consent
• If the request concerns exchange traded products (not OTC) or the exchange has less than €1trn open interest, a 30 month exemption can be granted by the European Commission,

A CCP can refuse an access request if:

• Trade volumes would be too large to process, within the capacity plan of the CCP
• The number and type of new Clients or Members would be too large for the CCP
• The CCP does not support the new products
• The CCP’s costs are too substantial to support the request
• The exchange is in a jurisdiction where the CCP cannot enforce its rules
• The link would fragment liquidity
• The link would adversely affect systemic risk
• The link would require the interoperability approach (above) unless all parties consent

In either case a request for access can take between 3 and 6 months to process, before either party has to respond.

What next?

Given the number of obstacles to achieving a successful request, and the need for a substantial number of users to move as a herd to achieve effective benefits, and that the regulators of a CCP or Exchange can cite liquidity fragmentation as a reason to refuse, can anyone see this having any major effect?

No-one anticipated the potential merger of the LSE Group and Deutsche Bourse, which would bring together two large pools of cleared business, regardless of the Open Access regulation. Maybe in the long term the combined group would offer to clear business from any European Exchange and bring about consolidation of clearing in Europe?

We won’t know any of this before 2018 when MiFID 2 might become effective, which itself is now subject to an uncertain delay.

This article was first published in edition 6 of Rocket, our magazine. Download available Rocket editions here, and save your up to date address in your profile to to indicate your interest in receiving a printed copy of the magazine. Copies are also available to purchase and subscribe to via the shop.

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