CloudMargin’s Industry Insight Series has been specifically created to shine a light on critical areas and themes within the financial services industry. Once a month, we will showcase expertise and viewpoints from industry figures who will highlight and discuss important areas in the market. The series has been designed to educate, inform and help you better understand complex issues within an ever-changing financial landscape.
Nick Horn, Suncorp
Nick Horn joined Suncorp Group in August 2016 as Senior Financial Risk Adviser, providing advice on investment assets, capital and liquidity as it applies to Stress Testing. Prior to this Mr Horn spent 6 years at QIC, departing as Manager of the Independent Investment Risk & Compliance function. At QIC, he co-led the business response to global derivative reforms. Mr Horn has been an active adviser to regulators & industry associations on the design and impacts of derivative reform. Mr Horn’s prior roles include Asset & Liability Management Specialist, Fund of Fund Equity Portfolio Manager, Derivatives Trader & Financial Advisor.
Stick finally meets carrot in promoting clearing for APAC buy-side
Since 2014, industry headlines have celebrated the shift of OTC volumes to CCPs, with little focus on the pedestrian uptake of clearing by the APAC buy-side.
Buy-side indifference is understandable: the incentives of deeper, resilient liquidity and better pricing remain hard to quantify, with clearing potentially adding material cost and complexity in the short term. Meanwhile, the bilateral market has largely witnessed BAU (Business as Usual) servicing.
Unfortunately, if clearing is the avoidable elephant-in-the-room, settling new compliant credit support arrangements is the unavoidable woolly mammoth crouching behind it.
Everything changes from March 1st 2017, when uncleared OTC trades become subject to mandatory margining.
From this date, many participants face the possibility of a complete loss of market access, in the absence of either compliant CSAs for bi-lateral trade or a Clearing Broker relationship to facilitate cleared trade at CCP venues.
Ironically, buy-side participants that (to date) were least incentivised, least resourced or least serviced by clearing brokers to access CCPs, are those most likely to experience the largest disincentives of future bi-lateral trade. Adding insult to injury, it is highly probable these same clients occupy a spot on the ‘low-priority list’ of relationships that banks are frantically attempting to triage in order to continue service after March 1st.
As I write, ISDA report that, globally, less than 5% of CSAs have been amended to achieve compliance with new rules, 3 weeks out from the effective date. For the industry, this is confronting enough, but rest assured that the buy side are laggards within this worrisome statistic. How did we create so much last minute panic and what does the future hold?
Regulating APAC Markets – A tough task
Regulators outside of the US & EU have a particularly narrow fairway to aim for. Two-way trade with the world’s largest capital market is essential for the health of your home economy, and alignment of terms is necessary for market access and competitiveness. Choices are:
1) Pass reforms early
This risks misalignment with the US & EU, creating an accumulation of costly hoops for home participants to jump through, and likely revisions to achieve the Holy Grail of international ‘equivalence’.
2) Pass reforms late, waiting for US & EU clarity
This risks a compromise to options available, tight deadlines for implementing global initiatives and limiting clarity for home participants on how/when they best maintain international trade. The “wait and see” approach may well be preferable. It is, at the very least, defensible and is widely employed in APAC. In Australia, regulators (understandably) sought to retain ‘choice’ for the buy-side, refraining from imposing obligations to clear on the broader market.
Unfortunately, a lack of regulatory imposition also breeds a lack of urgency. This is why, at the eleventh hour, we observe the majority of the buy-side late to the existing scramble to agree bilateral terms in order to retain any market access.
No docs no trade
The volume and complexity of global derivative reforms has led many to adopt a simplified approach to managing their business: “What regulation am I captured by?”
This ‘compliance only’ view lacks commercial rigour and is the cause of slow realisation that the requirement to act applies with limited discrimination as to who or where you are, assuming you trade with large, highly rated bank counterparties. Without new CSAs in place, a bank captured by uncleared margin rules will not be able to enter new trades with you, as it can’t demonstrate that it complies with the governing law of its jurisdiction of establishment and regulation*. There’s no negotiation to conduct here.
2017 and beyond- commerciality trumps compliance
In an era where growing bank costs are explicit within regulations and those costs are heavily influenced by what/how they trade with clients, we should expect to see more ‘user pays’ business models.
With that lens, and befitting of the year of the Rooster, the following chickens are well on their way home:
- The direct costs of cleared bilateral trade will become more apparent and widen, revealing the commercial benefits of clearing to a broader segment of the buy side.
- Product and relationship developments that minimise bank capital, funding and liquidity costs will become a shared incentive of the buy & sell sides.
- More asset classes and product types will be unveiled by CCPs, due to commercial (not regulatory) drivers. Large users are already realising cost, operational and risk management efficiencies of trading as much as possible on-exchange.
- Efficient collateral management will find its way into business projects, rather than being a concept to explore in the future.
*APRA’s six month ‘best endeavors’ clause in Australia still demands trades entered into or amended after March 1st comply by Sept 1st 2017. Should regulators acquiesce to industry appeals for a delay to rules, this will similarly provide no true relief from the commercial difficulties faced by many participants. To remove doubt, President Trump has made clear he is willing to tear-up regulation which impedes on commercial prosperity for the masses, as driven by the cost and ability of banks to service clients. Uncleared margining rules are not only beyond Trump’s reach, being part of global regulation rather than borne of Dodd-Frank, but they may also be found to support his cause, in time. But that’s another story…
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Disclaimer: The information provided in the article are views of the author and do not express in any manner whatsoever, the views of Suncorp. Under no circumstances shall Suncorp have any liability whatsoever for any information contained in the article or any reliance upon or otherwise resulting from or in connection with or relating to the use of (including the inability to use or the misinterpretation of) the article. No responsibility is accepted by Suncorp as to the accuracy or validity of the information in the article.