TomasKindler
CCP interoperability continues to make somewhat uneven progress across Europe. At the Global Custody Forum,Tomas Kindler, head of clearing relations at SIX Securities Services, presented on the status of interoperability in the cash equities space. AST catches up with him on the sidelines of the conference
AST: What do you want to make sure to get across about interoperability?
Tomas Kindler: Interoperability is really market driven, not regulation-driven - it has become reality, it is working and market participants are leveraging this new framework. To give one very concrete example, we switched the exchanges that were interoperable in the past to the new framework - the London Stock Exchange (LSE) and SIX Swiss Exchange - in July and between that time and today, we have doubled our market share in the London Stock Exchange. We are now at 25 per cent of the clearing volume of the LSE. The market wants competition and choice and ultimately when market participants pick their CCP of choice, that makes the market more efficient and cost efficient from both a product and service perspective.
AST: At the same time “inter-CCP” risk is now a factor that will require additional collateral. How much of a drawback will that be for the interoperability model?
Kindler: This is a key element of the new interoperability framework demanded by regulators. The old model foresaw a reuse of collateral to cover the inter-CCP risk, but this was no longer considered appropriate by regulators and the new framework they have approved requires the CCPs to cover the inter-CCP exposure by additional collateral. And that is on top of and independent of collateral collected as margin. So, yes, it means increased collateral requirements. There are different strategies applied by the CCPs to ensure they collateralise their exposure to the co-CCP.
We have opted for a hybrid model, where we collect 50 per cent from clients and contribute 50 per cent ourselves because we believe the market should not bear the full additional cost of interoperability. I think our competitors have opted to collect the full amount from their clients but that is their choice.
On the other hand, because market participants now have the opportunity to consolidate business across various venues in a single provider, that drives collateral efficiency. There is only one default fund contribution and margins can be offset across multiple venues; that clearly lowers collateral requirements.
The bottom line is that interoperability increases collateral efficiency and reduces collateral requirements.
AST: One of your observations of European players in the cash equities space is that two “camps” are emerging. Can you elaborate on that point?
Kindler: One is the majority of the MTFs – including Bats, Chi-X, Turquoise – and some regulated exchanges such as LSE, SIX Swiss Exchange and NASDAQ OMX, that support interoperable clearing with four to five CCPs competing in that space. This represents roughly 60 per cent of clearing volume. Then you have the other 40 per cent which mainly process along the vertical domestic value chains, so the German, Italian, Spanish and Greek markets, among others. There you have vertically integrated market structures that have not embraced interoperability yet. That is what we are seeing and I think it is a hard nut to crack because from a purely commercial perspective, there is no incentive for those exchange groups to open up clearing.
AST: What do you think it might take to open up those markets?
Kindler: From my perspective, it will probably take a combination of remedies in the context of mergers and future regulation, such as EMIR and/or MIFiD II, to force the markets to open up. But then looking back at MIFiD I, although the regulation was introduced more than four years ago, there are still a few markets in Europe that have not implemented it. So, just the fact that the regulation is likely to be ready by 2013 does not mean that the markets will open up automatically.
AST: Is there any answer as to how interoperability will help to push what many market participants feel is much-needed consolidation?
Kindler: In terms of interoperability triggering consolidation, when it comes to the 40 per cent of the European market that are organised along vertical silos, no, there is no firm answer. There are potential answers that I have just outlined such as regulation, but otherwise, not really. But for the other 60 per cent that are contested, well yes, there are answers. In light of interoperability, all the CCPs have introduced new fee schedules with significantly reduced prices. Some have introduced fee caps, like LCH.Clearnet and EuroCCP. From a revenue perspective, the pie is somewhere between €25 to 35 million in annual clearing revenues. That is maybe enough for two CCPs, but not for four or five. I think we will see natural selection if you will and scale is an important factor because it allows you to have the lowest unit cost and also to offer competitive pricing. With all the incoming regulations and focus by supervisors, risk management will move up higher on the agenda of selection criteria. How robust is the CCP, how well is it capitalised and supervised? And ultimately, sustainability is a factor because market participants want to pick a provider that is in it for the long run and not out of the business in the next two years.
AST: You also discuss some of the issues for CCPs in overcoming fragmentation in other asset classes such as derivatives. Can you elaborate on that point?
Kindler: We are not in the derivatives space, but what you have is on-exchange and OTC derivatives. On-exchange derivatives are by design vertical silos, because all the large derivatives exchanges have their own clearing house - it is a crucial element to create and list new products. Those are closed and for the time being there is no fungibility between similar contracts traded on different exchanges.
No exchange and clearing house has shown any interest to give access to open interest, so it remains a fragmented space and there are no signals that this is going to change any time soon.
As for the OTC market, which is in the spotlight right now, there is a regulatory push towards CCP clearing. It is a huge market at some $700 trillion and so a great potential for CCPs. What we have seen over the last two years is CCPs entering that space and I have stopped counting, but there are easily 15 clearing houses on both sides of the Atlantic now which either offer OTC derivatives clearing or have concrete plans to do so.
Though it is a big market it does not require 15 different providers to service that market so there is an element of fragmentation as well.
But because it is OTC and not linked to a trading venue, it is up to the market participants
to select their provider of choice and I think we will see natural consolidation around a few providers.
