The all-in cost of participating in the OTC derivatives market is about to go up sharply – either through central clearing, or as a result of the new BIS (Bank for International Settlements) margin requirements for non-cleared derivatives, effective from December 2015

The Real Cost of Central Clearing

The all-in cost of participating in the OTC derivatives market is about to go up sharply – either through central clearing, or as a result of the new BIS (Bank for International Settlements) margin requirements for non-cleared derivatives, effective from December 2015. The choices clients in particular are making now are not easy and caveat emptor should be front of mind, especially when choosing a clearing member.

The cost of clearing is also going up due to macro business reasons. Over the past few years, Futures Commission Merchants (FCMs) have under-priced client clearing with a “land grab” objective, at unsustainably low prices. As a result, the economics of client clearing are quickly becoming untenable for many – hence BNY and RBS dropping out of the business recently (and inevitably there will be more). Part of the argument will come down to your belief in whether you can win profits in the execution space – or whether you need to provide the clearing service to encourage customer loyalty with reduced execution fees.

Reduced competition will enable survivors to consolidate market share and push up prices to levels that can actually support their business. The end result will of course be higher prices paid by clients for client clearing. Our research shows that not only are there a wide range of prices being charged by banks for their clearing services, but the basis on which they are calculated are inconsistent, making it tricky for an apples-to-apples comparison [see table below].

So, what are the other lessons that can be learned as we step deeper into this new and not always so transparent world of clearing?

1. Expect to see Clearing Brokers continue to fine-tune their fees as they seek to claw back the true costs of clearing from their clients.
2. Complexity is increasing along with the need for tools to manage it.
3. Central Counterparties (CCPs) need to provide members and clients with explicit detail on their OTC margin models. If they don’t do this voluntarily, regulators will probably make them do so anyway.
4. Whilst the details of CCP margin models are available to members, the details of the default fund calculations can be more opaque. Expect further investigation by regulators into how IM (Initial Margin), DF (Default Fund) and the default waterfall are calculated and interact, such as VM (Variation Margin) haircutting and utilisation of non-defaulters’ IM asset pools.
5. Eligible assets to cover IM will expand, given the wide range at some CCPs compared to others. What a CCP regards as a stable asset needs to accommodate the squeeze on high-quality liquid assets going forwards.
6. Another growing need is liquidity management, for which the starting point is the ability to predict and analyse the increased number of daily margin calls.
7. The systemic effects of a VaR model used so prolifically in a stressed market has to yet to be seen in practise, but is something the whole market must be wary of.

Sample fees charged by Clearing Brokers

Access to clearing via direct members attracts charges from Clearing Brokers (outside the US) and FCMs (within the US). Under EMIR Clearing Brokers must disclose those fees publicly, a sample of which we've shown here. All the Clearing Brokers explain at length that the cost of building and operating their infrastructure is expensive, along with capital and funding costs, below are the sources for this data which explain in more detail why these charges are levied.

ISA = Individual Segregated Account. OSA = Omnibus Segregated Account

Fees from Clearing Houses under EMIR

Under EMIR the CCPs must also publicly disclose the fees they charge for their various account models. Here are some examples, excluding the usual membership fees, only those relevant to the new EMIR accounts:

The models adopted by each CCP vary widely, given that they each have different strengths in product sets, and focus on different national or vertical markets. Shopping around isn’t so easy, as price is just one component of your choice of CCP. In relation to amounts charged by the Clearing Brokers, the CCP charges are minor.

The competition for business is evident from the varied fee structures above. As the European Mandate draws closer, we may see adjustments to their models as Clients arbitrage the various models to get the best deals.

In the next article in this series, we’ll be looking into making the most of clearing and the different costs that need to be taken into account to optimize the capital allocation decision across clearing venues, clearing brokers, and listed versus OTC products.

Data Sources

We have checked carefully to assemble the summary tables above, taking information from the many web pages and PDFs below. If you spot any errors or omissions please let us know via this site and will gladly make amendments accordingly.

Clearing Brokers

• Citi: http://icg.citi.com/icg/global_markets/product_solutions/citi_futures.jsp
• Morgan Stanley: click here (or search for Morgan Stanley EMIR fees disclosure)
• JPMC: https://www.jpmorgan.com/pages/disclosures
• Barclays http://realizations.barclays.com/pdf/Pricing_Schedule_for_Listed_and_OTC.pdf
• UBS http://www.ubs.com/global/en/investment-bank/hedge-funds/futures-and-options.html
• Goldman Sachs http://www.goldmansachs.com/disclosures/gsi-cost-disclosure-statement.pdf
• DB http://cbs.db.com/new/docs/DB_Clearing_Member_Price_Disclosure_Document_10042014.pdf

CCPs

• Nasdaq OMX: http://www.nasdaqomx.com/digitalAssets/91/91722_140407-app_03_fee-list.pdf
• LCH http://www.lchclearnet.com/about_us/corporate_governance/ltd_account_structures_under_emir.asp
• CC&G: http://www.ccg.it/jportal/pcontroller/AllegatoHandler?lingua=2&allegato=131606
• CME: http://www.cmegroup.com/europe/clearing-europe/clearing/cme-clearing-europe-fees.html
• ICE: https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Fees.pdf
• Eurex: http://www.eurexchange.com/exchange-en/about-us/news/698148/
• EuroCCP: http://euroccp.com/sites/default/files/euroccp_regulation_fees_and_penalties_20140301.pdf