The first FCM faller | BNY bags client clearing
According to this IFR story, BoNY Mellon has cut its OTC clearing business due to "market and regulatory factors that will limit our ability to grow the business".
At the end there's a nice quote from Will Rhode of Tabb summing up the headwinds faced by client clearing businesses as "balance-sheet intensity of the business, all the necessary technology investments, the cost of operational staff, as well as the capital cost associated with the clearing house guaranteeing funds and provisioning intraday liquidity on clients’ behalf".
Perhaps this decision reflects idiosyncratic BoNY Mellon specific strategic circumstances or maybe – not being a significant IRS trading house – BoNY's departure as a bad sign for the standalone revenues and return on capital of client clearing businesses in general.
Certainly the thrust of the joint trades letters on Basel III CCP capitalization and leverage ratio indicate some many-fold over-capitalization issues for client clearing brokers – see my prior post on this.
Client clearer economic viability
If custodians are starting to throw in the towel, G20 regulators need the role of an OTC clearing broker to be a viable long term proposition at least for banks to avoid excessive concentration on a few client clearing brokers, offer customer choice and provide robust infrastructure and capital strength. This could either be standalone viable or via cost and revenue synergies or bundling with financing services, OTC trading or other revenue lines.
What's the fix?
Many banks and regulators are hoping that BCBS can once again iterate the CCP capitalization and leverage ratio model to a point of accommodation which will render providing client clearing long-term viable. An adequate compromise may come.
But it could in theory at least be worse: default fund exposures even when appropriately capitalized could be so significant that client clearing is economically unsustainable for any bank? At this point the problem is clearly not capital but the level of client clearing risk to the clearing broker.
Now regulators would need to choose between abolishing client clearing (and having clients self-clear as clearing members) or finding a new client clearing operating model which is much lower risk to the clearing broker.
A new client clearing model?
Revising the market standard client clearing operating model might take, say, a couple of years or more. If client clearing economics don't stack up we may only find out only slowly – e.g. as OTC trading revenue is eroded by regulatory measures and mandated client cleared risk grows steadily as legacy portfolios transition we may see more banks pull out of the clearing business over several years. Then suddenly consensus would form that this was critical and time would be tight to solve it.
So how about we start to think about this now? My 10c to get the ball rolling would be the "pure agency client clearing model". I will elaborate in a separate post in the near future.