December 14, 2011

Michelle Neal at Nomura suggests large dealers won’t join JSCC

In this article from Reuters, based on discussions at the FIA conference in Singapore,  Michelle Neal, global head of electronic markets, futures and OTC derivative clearing at Nomura, said “I could envisage a situation where other banks that are big clearers today may decide not to join the Japan CCP (central clearing counterparty) for example“.

The main thrust of the article is that the business case for domestic clearing in many of the G20 countries such as Japan, Australia, Canada, Korea, Poland and others just isn’t there. The complexity and cost of creating and running a CCP for OTC products will far outweigh the income driven by the small volume of trades to be cleared within their domestic markets. My own feedback from other sources corroborates this point of view.

As readers will know, a high proportion of OTC trades cross national boundaries with the G16/20 banks acting as wholesalers, distributing the products out via local subsidiaries to regional end users. Even in the UK, I doubt there is a large market for GBP rate swaps, executed between UK domiciled organisations. Most end-users who qualify to use OTC products are already trans-national in scale, and use OTC products to hedge FX and Rate risk caused by their cross-border activities.

Adding into the mix the likelihood that mandating the clearing of all trades in a currency (e.g. CAD) via a domestic CCP would mean initial margin amounts being paid once domestically, and again at higher levels to a global CCP where the absence of those trades would reduce risk netting, is also a barrier to the success of domestic clearing. (In other words, the only sensible mandate is to clear local trades in the national currency between local firms domiciled in that country, sort of local clearing for local people).

In reality the OTC market is global, and can’t easily be modelled as a domestic market, causing the regulatory drivers to be orthogonal to the reality of the actual market structure in place now.

My suggestion: create a global regulator, with the mandate to sponsor and drive global clearing solutions, backed up by global systemic risk solutions to the stability of the global CCPs.  This may also be hard to achieve, and cuts across domestic governments, but without the regulators taking a global view, the G20 mandate for clearing in many countries may fizzle out given the cost and complexity barriers above.

Size matters for CCPs.

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