The global push towards central clearing of over-the-counter (OTC) derivatives and swaps brings challenges in terms of costs and timing, but it has also reduced counterparty risk and brought other efficiencies to trades.

At the CFA Australia Investment Conference 2017, held in Melbourne last month, a panel of experts evaluated the impact of reforms in clearing, both globally and within Australia, and made observations about the incoming initial margining rules as well.

BlackRock director, trading and liquidity strategies group, Stuart Anderson noted that after regulators in major markets like the US and Europe mandated clearing of various OTC derivatives, Australian market participants largely adopted the practice because of the necessity of trading with brokers in those larger jurisdictions.

Anderson cited figures from the Bank for International Settlements (BIS), which found that from June to December 2016, the proportion of interest rate swaps cleared versus uncleared was “relatively stable”, around 75 per cent to 76 per cent, while the proportion of cleared credit derivative swaps rose from 37 per cent to 45 per cent. He said Australia’s rate of centrally cleared trades probably approximated those figures.

The Australian approach

“Australia took a very different approach, not mandating, as far as the buy side is concerned, that those products had to be cleared but leaving it to market forces to address that,” Anderson explained. “I think that’s worked very effectively, certainly for the large international firms like ourselves – where we are trading with US or European brokers in the majority of cases – to get best execution. And we have had to adhere to their regulatory timelines as well.”

PIMCO executive vice-president and fixed income portfolio manager, Adam Bowe, said that whilst there have been challenges associated with moving to centrally cleared derivative transactions, there have also been benefits.

“One of the challenges is that when you’re clearing, the lifecycle of a trade shrinks,” Bowe said. “You need a lot more efficiency in execution to be able to manage that. You have clearing windows at exchange houses that you have to meet, you have reporting requirements to regulators, so if any errors happen along the way with a compressed trade lifecycle – from when you get an order, and when you execute it and it’s done – there’s not a lot of slippage in terms of correcting that.”

But there were also benefits beyond just the intention of regulators, in terms of reducing counterparty risk, Bowe added.

Efficiencies in margining

“As a manager of client assets, we want to be doing the most efficient things, in terms of getting best price and most liquid products, and now that clearing, particularly interest rate swaps, is the norm, that’s on the cleared derivatives side now, without a doubt.”

The other concern in the market was the impact of the launch of initial margining rules, which started for large international firms in September 2016 and expanded to include smaller players from September 2017.

CME Group director OTC products Shawn Creighton said that, regarding margins, clearing has brought many efficiencies.

“From our standpoint, trading in the OTC market as well as the listed market, there are efficiencies we can offer for margining, with a portfolio margin program that has offsets between listed and OTC products that clear,” Creighton said. “To answer the question, ‘Is margining going to hinder liquidity?’ I don’t see that happening. I think bringing those products to central clearing opens up the market to more participants and allows in more individuals to broaden the counterparties.”

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