Central counterparty clearinghouses (CCPs), which play a key role in managing risks in the financial system, are also important in helping ease sell-side market participants' burdens associated with Basel III compliance.
“Our customers, the large banks, are heavily impacted,” said Matthias Graulich, member of the Eurex Clearing executive board and chief client officer. “In particular, the leverage ratio creates significant issues for the client clearing business.”
The impact of the Basel III leverage ratio rules on the client clearing model is that cash collateral is regarded as additional leverage, and any collateral collected, be it cash or securities, cannot be used to reduce the trade exposure leverage.
“That makes the client clearing business very expensive, which is currently being discussed with the regulatory bodies, in particular the Basel committee,” said Graulich. “From our perspective, the current requirements are not in line with the G20 mandate -- in contrast it creates economic disincentives to offer clearing services for clearing brokers.”
Historically, clearing brokers could use margin collateral to leverage themselves, but are no longer permitted to do so.
“What is a game changer here are the segregation rules,” Graulich said. “For example, looking at individual segregation structures – the clearing broker cannot do anything with the collateral that is provided by clients to fund margin requirements. It has to be instantly forwarded to the CCP, therefore it can, in no way, be used to leverage the bank itself as an intermediary.”
The need to look at capital efficiencies and margin efficiencies under these new rules has increased the importance of an efficient collateral management offering by CCPs across the different products via “securities lending, repo and derivatives combined with intelligent membership types, “ said Graulich. “Bringing all these products onto a CCP with direct buy-side membership structures will reduce RWAs and leverage.”
Matthias Graulich, Eurex Clearing
Eurex Clearing is “participating in the discussion process because we believe that the current rules are not really reflective of the facts around leverage,” he added. “One immediate measure to mitigate some effect under the existing rules is to use securities instead of cash from the client side and directly passed onto the CCP, as this does not mean additional leverage. As a CCP with a very broad range of additional collateral, we are helping to make use of securities collateral as far as possible.”
Another possibility is to allow direct access models into the CCP. Eurex has already implemented such access models in securities lending and repos, whereby it provides the beneficial owner--the buy side firm--with special direct access to the CCP. The other side, the borrower of the lending transaction, usually a large sell-side firm, also has direct access to the CCP.
“This original relationship which would translate into a client clearing relationship, where only clearing brokers have access to the CCP, disappears and suddenly in that transaction, the beneficial owner and lender of the security and the borrower don't have a bilateral relationship anymore and only face the CCP," said Graulich.
BNY Mellon and State Street have agreed to provide access for their clients to Eurex Clearing’s Lending CCP service.
"We are continually monitoring the regulatory and structural changes taking place in this market and view central clearing as a key additional distribution method that will help to support market demand for our clients’ securities,” said James Slater, executive vice president and BNY Mellon’s global head of securities finance, in a release. “Together with Eurex Clearing and State Street, we look forward to further enhancements to the clearing model for agent lenders and beneficial owners.”
For banks, i.e., the borrowers, this means they can apply multilateral netting for all their transactions, which has a positive impact on the leverage ratio. Even more important, they only have a 2% risk weight versus a 20% + risk weight they would have facing the bilateral counterparty.
“These models we already have implemented and are available on the securities lending side and on the repo side, where we currently see an increasing demand,” said Graulich. “What we are currently looking into is to expand such special direct membership types.”
Compression is another element to bring down the exposure, as are advanced netting regimes. “Compression is a little more complex because it requires interaction with other market participants. Additionally compression usually changes slightly the risk profile within certain pre-defined parameters,” Graulich said. “The importance of advanced netting regimes, for examples, so-called rate blending, is likely to increase going forward as it can be used unilaterally, so independent of other market participants. The more standardization we see, e.g. on payment dates and coupon dates, the more unilateral netting will be able to take place similar to the futures world."
Featured image via justyle/Dollar Photo Club
