Smaller funds most at risk if mid-tier PBs ditch clearing businesses
Smaller buy-side firms trading swaps could potentially be shut out of OTC markets as a growing number of prime brokers increasingly question the risk-reward ratio of acting as clearing members, it has been warned.
“The big banks will not leave the clearing business although some of the smaller, Tier 2 organisations might, which could pose a challenge for buy-side firms that only have one clearing member. Smaller firms could struggle to find a new clearing member in good time, which could have serious ramifications on their business. Furthermore, those banks which stay in the clearing business are likely to prioritise the bigger buy-side players,” said Jeremy Bezant, independent consultant, speaking at the Trade Tech Swaps and Derivatives conference in London.
Prime brokers embraced mandatory clearing because it meant they could be gross to the market and net to the clearing house in a collateral sense. However, the CFTC has nixed that, and therefore the scope to rehypothecate excess collateral has shrivelled up. “Prime brokers believed mandatory clearing would be a cash cow but this has not materialised,” added Bezant.
Anthony Belchambers, chief executive officer at the Futures and Options Association (FOA), the industry organisation representing businesses engaged in derivatives trading, agreed. “I have heard that one or two clearing members have contemplated pulling out of the business as they do not believe the risk-reward ratio is justifiable. However, they are not mainstream clearing firms and there are no final decisions yet,” said Belchambers.
Nevertheless, larger prime brokers are likely to continue subsidising clearing. However, were a tier 2 clearing broker to exit the business either through choice or default, there would be a surge in smaller firms seeking a new clearing broker. Negotiating and finalising a clearing broker agreement is a time consuming and onerous task for buy-side firms. It is also debatable whether the remaining clearing brokers would have the capacity to onboard all of these clients.
Bezant was more nuanced. “If a clearing member exited the business through choice, it would be phased in giving clients time to find a new member. However, I do not expect it to affect the big hedge fund or buy-side clients as they are likely to have multiple clearing broker relationships. All they would need to do is port their assets,” he said.
European regulators had hoped to finalise rules regulating the OTC market by the end of 2012. However, most market participants expect implementation to be further delayed by anywhere between six months and two years.