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ISSN: 1467-2650 © 2008 P&L Services Ltd. All Rights Reserved
                       This article first appeared in: Profit & Loss Magazine,
                                           June 2009 | issue 102 | Volume 10
                                  visit our website: www.profit-loss.com




Clearing and the 10-Tonne CCP Gorilla
PROFIT & LOSS AND INEUM CONSULTING PARTNERED LAST MONTH IN LONDON TO HOST A
SEMINAR THAT FOCUSED ON CROSS-ASSET CLEARING AND REGULATION IN THE OVER-
THE-COUNTER DERIVATIVES MARKET. HERE’S WHAT WAS SAID...
                                                                           “We refer the European Commission back to
                                                                           worries over excessive drives to standardisation
                                                                           which is very easy to do from a top down macro,
                                                                           prudential approach, but it doesn’t help the end
                                                                           users all of the time”

                                                                           setting the scene for multi-asset trading, cross-asset class
                                                                           clearing. First, he noted that there has been widespread




       A
                                                                           adoption of e-trading systems by the buy side with more than
                                                                           50% of respondents in a 2008 Sifma survey saying that more
                                                                           than 80% of their trading was done through electronic means
                                                                           – either via a platform provided by sell side players or through
                                                                           direct access to the market.
                                                                              Buy side firms are using e-trading because it is efficient and
                                                                           reduces costs. Those that don’t use it, according to Mathias,
                                                                           say it is because there is a lack of good technology and a lack
                     jointly hosted seminar by Profit & Loss and Ineum     of multi-asset capability (where one can trade a number of
                     Consulting, a strategy, organisation and              separate, non-correlated asset classes through the same
                     information systems consulting company, fea-          system) being provided.
                     tured a look at multi-asset trading and cross-asset      “The buy side works on a portfolio basis so they think
       clearing, particularly the evolving customer and regulatory         multi-asset. The sell side doesn’t necessarily do this and that’s
       drivers, and the industry’s response. Attendees at the May 12       when you get a fundamental, almost a structural disconnect
       breakfast in London drew a diverse, standing room only              between the buy and sell side,” suggested Mathias. “The buy
       crowd from exchanges, banks, buy side firms, technology             side likes multi-asset trading because it helps their portfolios
       companies and clearing organisations.                               and also reduces their time scale for trading as they can be
          Moderated on behalf of Profit & Loss by David Setters,           much more responsive to the market when they see everything
       senior associate at Contango Markets, the panellists included:      delivered on one screen.”
       Martin Frewer, senior manager, Fortis Global Clearing; Mike            The sell side, he said, tended to have a governance issue.
       Mathias, partner, financial services, Ineum Consulting; Alex        “Banks are arranged by desks – swaps desks, equities desks,
       McDonald, CEO, the Wholesale Markets Brokers’                       FX desks and futures desks – and the way the sell side thinks
       Association (WMBA); Jérôme Rousseaux, deputy head, post             is along those desk-based silos,” Mathias contended. “You get
       trade services, Sungard Global Trading; and Richard                 specialist traders, specialist back offices and specialist back
       Wilkinson, director, clearing and infrastructure sales, futures     office systems based on these individual silos.”
       and base metals, RBC Capital Markets.                                  As the market moves on, buy side demands will be even
          The panel discussion was divided into two broad topics:          greater, he said. “What you’re finding is that the buy side is
       The first looked at whether the industry had moved on from          now requiring more than mere multi-asset trading
       plain vanilla multi-asset trading and cross-asset clearing and if   requirements. They need to be able to correlate the multiple
       supposed ‘road blocks’, such as a silo mentality by the banks       assets they have into a single portfolio and be able to stress
       and a lack of suitable back office technology had been              that portfolio as a single unit. What they are now demanding
       removed. “We will see if more pieces of the jigsaw have been        is cross-asset trading.”
       filled in,” said Setters.                                              He says that while the sell side has responded with the
          The second part of the discussion focused on the “10 tonne       introduction of the prime broker paradigm, which tries to pull
       gorilla in the room” – the issue of central counterparty            together a cross-asset view for its clients, it still has a back end
       clearing for OTC derivatives.                                       that is siloed even if the front end does look much better.
          Ineum Consulting’s Mathias kicked off the discussions by         “You’ve still got the manual processes and the operational risk


  30         June 09   I Profit & Loss I www.profit-loss.com
SPECIAL REPORT: DERIVATIVES




                                                                 “The buy side works on a
                                                                 portfolio basis so they think
                                                                 multi-asset. The sell side
                                                                 doesn’t necessarily do this
                                                                  and that’s when you get a
                                                                 fundamental, almost a
that arises from having to pull together those positions, those
                                                                 structural disconnect
P&Ls and the client reporting from the back end,” he said.        between the buy
   However, RBC’s Wilkinson contested some of the
suggestions. “I think the sell side has responded to
                                                                 and sell side.”

providing multi-asset trading capabilities. It differs
according to whom you trade with but the sell side is
certainly aware of it and developing DMA cross-asset
strains that would reduce the amount of real estate desktop
which is key to the buy side.”
   Wilkinson did, however, say that the challenge for the sell
side lies in post-trade management where traditionally MIKE MATHIAS, PARTNER, FINANCIAL SERVICES, INEUM CONSULTING
“everything that has been OTC has gone down a siloed pipe
and has been managed by relevant experts in the back prime brokers and credit concerns generally. The regulators of
offices”.                                                         course want transparency.”
   He said the biggest challenge going forward is to develop a       McDonald questioned whether a generalised usage of
cross-asset clearing capability. “In a bilateral world I still central counterparties is desirable and feasible. He pointed out
think it is important to go down, to a certain degree, the siloed that a push to CCPs has been in a number of areas including
pipe because you’ve got the product experts. As we move interest rate swaps, commodities, climate emissions,
more into a cleared world where we have a central electricity and of course credit default swaps, and for most it
counterparty, the sell side’s relationship with the customer has proved to be a “good model”. But for some products it is
changes. You just give the trade out and it puts the onus more not always desirable.
on the clearing broker to manage the margin process and              “Certainly, I would say look at the FX market which is the
manage the risk to a client.                                      biggest and most transparent and the most traded wholesale
   “The challenge is going to be how we deal with the new market and no-one really talks about CCP there. CLS works
OTC products that are going to be possibly forced by very well as do OTC derivatives products in a peer to peer
regulators onto the exchanges and onto CCP clearing,” he area. But I would point everybody to look at the initiative that
added.                                                            has been launched by CME to see if longer dated FX products
   Frewer discussed Fortis Global Clearing’s business, which will indeed be moved to central clearing. We will really see
he said is able to facilitate the clearing of multi-asset and whether the desirability is there with the CME initiative.”
cross-asset classes. “One of the most important parts of this is     McDonald warned of excessive drives to standardisation
obviously the risk element. Clients want risk offsets, margin of OTC products. “We always refer the European
offsets and what we have been able to do is create our own Commission back to worries over excessive drives to
cross margin haircut system whereby we can take different standardisation which is very easy to do from a top down
asset classes and create, through various modules, a single macro, prudential approach, but it doesn’t help the end users
index. From that we have been able to expand laterally into all of the time because that’s not what the OTC market is
other asset classes.”                                             about. The OTC market is about wholesaling. When you are
                                                                  raising money and when you are distributing products, you
                      SHIFTING FOCUS                              don’t need to do it incrementally contract by contract. There
                                                                  is a utility to the OTC market and a utility to trade peer to
   Turning the spotlight on that 10-tonne gorilla, discussions peer which might not suit a CCP. So it’s not always
shifted focus to central clearing in OTC derivatives.             desirable as you might read in the papers or in the minutes
   The WMBA’s McDonald said the shift in the last year coming out of Brussels.”
towards CCP clearing has been driven by the buy side and             McDonald also talked about the cost of clearing to the buy
regulators. “The buy side have obviously been incentivised by side. “I don’t think the buy side has appreciated that both the
not only the whole cross margin advantages of putting their processing costs and cross margining costs are probably going
risk onto a CCP, but issues over the credit worthiness of their to be higher than they think.”


                                                                             www.profit-loss.com   I Profit & Loss I June 09      31

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Profit And Loss Magazine June 09

  • 1. ISSN: 1467-2650 © 2008 P&L Services Ltd. All Rights Reserved This article first appeared in: Profit & Loss Magazine, June 2009 | issue 102 | Volume 10 visit our website: www.profit-loss.com Clearing and the 10-Tonne CCP Gorilla PROFIT & LOSS AND INEUM CONSULTING PARTNERED LAST MONTH IN LONDON TO HOST A SEMINAR THAT FOCUSED ON CROSS-ASSET CLEARING AND REGULATION IN THE OVER- THE-COUNTER DERIVATIVES MARKET. HERE’S WHAT WAS SAID... “We refer the European Commission back to worries over excessive drives to standardisation which is very easy to do from a top down macro, prudential approach, but it doesn’t help the end users all of the time” setting the scene for multi-asset trading, cross-asset class clearing. First, he noted that there has been widespread A adoption of e-trading systems by the buy side with more than 50% of respondents in a 2008 Sifma survey saying that more than 80% of their trading was done through electronic means – either via a platform provided by sell side players or through direct access to the market. Buy side firms are using e-trading because it is efficient and reduces costs. Those that don’t use it, according to Mathias, say it is because there is a lack of good technology and a lack jointly hosted seminar by Profit & Loss and Ineum of multi-asset capability (where one can trade a number of Consulting, a strategy, organisation and separate, non-correlated asset classes through the same information systems consulting company, fea- system) being provided. tured a look at multi-asset trading and cross-asset “The buy side works on a portfolio basis so they think clearing, particularly the evolving customer and regulatory multi-asset. The sell side doesn’t necessarily do this and that’s drivers, and the industry’s response. Attendees at the May 12 when you get a fundamental, almost a structural disconnect breakfast in London drew a diverse, standing room only between the buy and sell side,” suggested Mathias. “The buy crowd from exchanges, banks, buy side firms, technology side likes multi-asset trading because it helps their portfolios companies and clearing organisations. and also reduces their time scale for trading as they can be Moderated on behalf of Profit & Loss by David Setters, much more responsive to the market when they see everything senior associate at Contango Markets, the panellists included: delivered on one screen.” Martin Frewer, senior manager, Fortis Global Clearing; Mike The sell side, he said, tended to have a governance issue. Mathias, partner, financial services, Ineum Consulting; Alex “Banks are arranged by desks – swaps desks, equities desks, McDonald, CEO, the Wholesale Markets Brokers’ FX desks and futures desks – and the way the sell side thinks Association (WMBA); Jérôme Rousseaux, deputy head, post is along those desk-based silos,” Mathias contended. “You get trade services, Sungard Global Trading; and Richard specialist traders, specialist back offices and specialist back Wilkinson, director, clearing and infrastructure sales, futures office systems based on these individual silos.” and base metals, RBC Capital Markets. As the market moves on, buy side demands will be even The panel discussion was divided into two broad topics: greater, he said. “What you’re finding is that the buy side is The first looked at whether the industry had moved on from now requiring more than mere multi-asset trading plain vanilla multi-asset trading and cross-asset clearing and if requirements. They need to be able to correlate the multiple supposed ‘road blocks’, such as a silo mentality by the banks assets they have into a single portfolio and be able to stress and a lack of suitable back office technology had been that portfolio as a single unit. What they are now demanding removed. “We will see if more pieces of the jigsaw have been is cross-asset trading.” filled in,” said Setters. He says that while the sell side has responded with the The second part of the discussion focused on the “10 tonne introduction of the prime broker paradigm, which tries to pull gorilla in the room” – the issue of central counterparty together a cross-asset view for its clients, it still has a back end clearing for OTC derivatives. that is siloed even if the front end does look much better. Ineum Consulting’s Mathias kicked off the discussions by “You’ve still got the manual processes and the operational risk 30 June 09 I Profit & Loss I www.profit-loss.com
  • 2. SPECIAL REPORT: DERIVATIVES “The buy side works on a portfolio basis so they think multi-asset. The sell side doesn’t necessarily do this and that’s when you get a fundamental, almost a that arises from having to pull together those positions, those structural disconnect P&Ls and the client reporting from the back end,” he said. between the buy However, RBC’s Wilkinson contested some of the suggestions. “I think the sell side has responded to and sell side.” providing multi-asset trading capabilities. It differs according to whom you trade with but the sell side is certainly aware of it and developing DMA cross-asset strains that would reduce the amount of real estate desktop which is key to the buy side.” Wilkinson did, however, say that the challenge for the sell side lies in post-trade management where traditionally MIKE MATHIAS, PARTNER, FINANCIAL SERVICES, INEUM CONSULTING “everything that has been OTC has gone down a siloed pipe and has been managed by relevant experts in the back prime brokers and credit concerns generally. The regulators of offices”. course want transparency.” He said the biggest challenge going forward is to develop a McDonald questioned whether a generalised usage of cross-asset clearing capability. “In a bilateral world I still central counterparties is desirable and feasible. He pointed out think it is important to go down, to a certain degree, the siloed that a push to CCPs has been in a number of areas including pipe because you’ve got the product experts. As we move interest rate swaps, commodities, climate emissions, more into a cleared world where we have a central electricity and of course credit default swaps, and for most it counterparty, the sell side’s relationship with the customer has proved to be a “good model”. But for some products it is changes. You just give the trade out and it puts the onus more not always desirable. on the clearing broker to manage the margin process and “Certainly, I would say look at the FX market which is the manage the risk to a client. biggest and most transparent and the most traded wholesale “The challenge is going to be how we deal with the new market and no-one really talks about CCP there. CLS works OTC products that are going to be possibly forced by very well as do OTC derivatives products in a peer to peer regulators onto the exchanges and onto CCP clearing,” he area. But I would point everybody to look at the initiative that added. has been launched by CME to see if longer dated FX products Frewer discussed Fortis Global Clearing’s business, which will indeed be moved to central clearing. We will really see he said is able to facilitate the clearing of multi-asset and whether the desirability is there with the CME initiative.” cross-asset classes. “One of the most important parts of this is McDonald warned of excessive drives to standardisation obviously the risk element. Clients want risk offsets, margin of OTC products. “We always refer the European offsets and what we have been able to do is create our own Commission back to worries over excessive drives to cross margin haircut system whereby we can take different standardisation which is very easy to do from a top down asset classes and create, through various modules, a single macro, prudential approach, but it doesn’t help the end users index. From that we have been able to expand laterally into all of the time because that’s not what the OTC market is other asset classes.” about. The OTC market is about wholesaling. When you are raising money and when you are distributing products, you SHIFTING FOCUS don’t need to do it incrementally contract by contract. There is a utility to the OTC market and a utility to trade peer to Turning the spotlight on that 10-tonne gorilla, discussions peer which might not suit a CCP. So it’s not always shifted focus to central clearing in OTC derivatives. desirable as you might read in the papers or in the minutes The WMBA’s McDonald said the shift in the last year coming out of Brussels.” towards CCP clearing has been driven by the buy side and McDonald also talked about the cost of clearing to the buy regulators. “The buy side have obviously been incentivised by side. “I don’t think the buy side has appreciated that both the not only the whole cross margin advantages of putting their processing costs and cross margining costs are probably going risk onto a CCP, but issues over the credit worthiness of their to be higher than they think.” www.profit-loss.com I Profit & Loss I June 09 31