Erik M眉ller: industry needs to overcome CCP restrictions
31 January 2019 Luxembourg
Image: Shutterstock
The industry needs to come up with better answers to overcome some of the restrictions regarding access to a central clearing counterparty (CCP), Erik M眉ller, CEO, Eurex Clearing, cited in this year鈥檚 GFF summit.
M眉ller explained that the objective 鈥渕ust be for buy-side firms, sovereigns and central banks, who are increasingly a client base for the CCPs鈥�.
Discussing what makes a CCP useful and unique, M眉ller said: 鈥淚t is the role of a risk manager in the financial markets and CCPs build a firewall if something bad happens in the financial markets.鈥�
He also noted that there is an increasing number of asset classes that CCPs serve, such as repo, securities lending, and foreign exchange.
鈥淗istorically they have concentrated on derivatives and have been well known in that space for decades but the big change came during the financial crisis when the governments said that they need further mechanisms of stability.鈥�
鈥淢arket participants have increasingly asked the clearinghouse to play a role in the funding and finance market. There are several CCPs in the world that offer that service. Eurex Clearing is the only EU CCP today that offers a solution to securities lending markets and cross-currency swaps.鈥�
M眉ller highlighted the number of securities on loan as he said that there are two trillion of securities on loan in the market in the world. There are 16 trillion in lending assets, according to statistics from the International Securities Lending Association.
The importance of CCPs was stressed as M眉ller explained that the financial crisis revealed that the concentration and interconnectedness of the banks can prove to be problematic.
鈥淚t proves particularly difficult to manage when execution happens in markets that are not regulated. Even the larger players found that they needed help during the financial crisis.鈥�
鈥淐CPs are useful because there are five unique concepts that make the CCP special. Through inserting the CCP between two counterparties, you have the ability to net exposures鈥攁 high degree of netting efficiency that is introduced to the system (95 plus percent).
Meanwhile, the second is the concept of variation margin. M眉ller noted that the CCPs mark to market the exposures.
鈥淲e don鈥檛 allow the build-up of credit exposures between participants. Every day worldwide, CCPs offset market risk and prevent build up over time of credit margin.鈥�
鈥淭he third concept is around initial margin, it anticipates future market swings and it is also applied increasingly in the bilateral market and uncleared markets; initial margin is a very successful concept.鈥�
M眉ller continued: 鈥淔ourthly, there is a unique mechanism that backstops initial margin, there is a backstop that is modelled after extreme but plausible events. This mechanism is called the default fund, which is reached by all participants of the clearinghouse including the clearinghouse itself.鈥�
Fifth, M眉ller stated, is that CCPs have in their rule book mechanisms that allow the CCP to rebalance itself should the four other solutions prove to be insufficient.
鈥淭hese costs should be spread among the beneficiary of the clearing environment rather than taxpayers. This makes CCPs unique; the last two of five elements mentioned created an important incentive structure that aligns the interests with the CCP and its members.鈥�
Discussing Brexit, M眉ller stressed that Brexit is important in the CCP world. He commented: 鈥淚n London and the EU 27 there are worries about the possibilities accessing that clearinghouses going forward. There are emergency rules being put in place but clients are asked by regulators to prepare for all scenarios and emergency rules are temporary in nature.鈥�
M眉ller explained that the objective 鈥渕ust be for buy-side firms, sovereigns and central banks, who are increasingly a client base for the CCPs鈥�.
Discussing what makes a CCP useful and unique, M眉ller said: 鈥淚t is the role of a risk manager in the financial markets and CCPs build a firewall if something bad happens in the financial markets.鈥�
He also noted that there is an increasing number of asset classes that CCPs serve, such as repo, securities lending, and foreign exchange.
鈥淗istorically they have concentrated on derivatives and have been well known in that space for decades but the big change came during the financial crisis when the governments said that they need further mechanisms of stability.鈥�
鈥淢arket participants have increasingly asked the clearinghouse to play a role in the funding and finance market. There are several CCPs in the world that offer that service. Eurex Clearing is the only EU CCP today that offers a solution to securities lending markets and cross-currency swaps.鈥�
M眉ller highlighted the number of securities on loan as he said that there are two trillion of securities on loan in the market in the world. There are 16 trillion in lending assets, according to statistics from the International Securities Lending Association.
The importance of CCPs was stressed as M眉ller explained that the financial crisis revealed that the concentration and interconnectedness of the banks can prove to be problematic.
鈥淚t proves particularly difficult to manage when execution happens in markets that are not regulated. Even the larger players found that they needed help during the financial crisis.鈥�
鈥淐CPs are useful because there are five unique concepts that make the CCP special. Through inserting the CCP between two counterparties, you have the ability to net exposures鈥攁 high degree of netting efficiency that is introduced to the system (95 plus percent).
Meanwhile, the second is the concept of variation margin. M眉ller noted that the CCPs mark to market the exposures.
鈥淲e don鈥檛 allow the build-up of credit exposures between participants. Every day worldwide, CCPs offset market risk and prevent build up over time of credit margin.鈥�
鈥淭he third concept is around initial margin, it anticipates future market swings and it is also applied increasingly in the bilateral market and uncleared markets; initial margin is a very successful concept.鈥�
M眉ller continued: 鈥淔ourthly, there is a unique mechanism that backstops initial margin, there is a backstop that is modelled after extreme but plausible events. This mechanism is called the default fund, which is reached by all participants of the clearinghouse including the clearinghouse itself.鈥�
Fifth, M眉ller stated, is that CCPs have in their rule book mechanisms that allow the CCP to rebalance itself should the four other solutions prove to be insufficient.
鈥淭hese costs should be spread among the beneficiary of the clearing environment rather than taxpayers. This makes CCPs unique; the last two of five elements mentioned created an important incentive structure that aligns the interests with the CCP and its members.鈥�
Discussing Brexit, M眉ller stressed that Brexit is important in the CCP world. He commented: 鈥淚n London and the EU 27 there are worries about the possibilities accessing that clearinghouses going forward. There are emergency rules being put in place but clients are asked by regulators to prepare for all scenarios and emergency rules are temporary in nature.鈥�
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