SLT: Can you explain what the partnership between Pirum and Eurex Clearing means?
Perry: What we are planning to do for CCP is very different to what any of the other providers have been offering. So far there has been a bit of confusion in the market between trading platforms and CCPs and they have often been talked of in a single breath. There is a close relationship because a CCP requires some sort of platform to provide flow through to it, but this platform can either be a fully-fledged “trading platform” or a much simpler “reconciliation platform” that simply matches trades which have already been agreed bilaterally before they reached the reconciliation platform. The trading platforms with CCP links so far have been focused around anonymous trading even though they usually have the ability to enter a bilaterally agreed “locked” trade - but generally that’s treated as the exception rather than the rule.
We are treating this very much as a post trade activity and will be using our reconciliation platform to feed bilaterally agreed trades to the CCP. At the moment, traders have many ways of agreeing a trade. Mostly they are pretty comfortable about doing autoborrow through autoborrow platforms and they’re pretty comfortable about negotiating transactions bilaterally over the phone / email / Bloomberg. Those methods cover almost all the transactions we have out there today. Our service will enable them to continue agreeing transactions as they do today, but then to take advantage of our link with Eurex Clearing to put some of these transactions through a CCP.
So why would a CCP be interesting to those guys? A CCP is interesting for credit risk reasons, especially given the increased focus on this area from market participants and regulators. So it’s about reducing credit risk and a CCP is an acknowledged way of doing that.
Therefore exposure, instead of being direct with the trading counterparty, is now with the CCP. Essentially you should end up with a much lower risk counterparty to deal with and one on which you can net activity with lots of different participants. Not so much for a lender, but more for a borrower.
And very importantly for a borrower, with all the Basel III regulation that is coming along, a CCP has a much lower risk weighting when you’re doing your capital adequacy calculation. Capital for banks is in increasingly short supply and we expect that going forward it’s going to become scarcer and that’s going to mean that firms need to use their capital more efficiently. A CCP is an extremely efficient counterparty from a capital usage point of view. Given its nature and its risk management procedures, CCP exposures benefit from a zero per cent risk weighting under Basel II. What a CCP does for you is take the exposure that would have had a higher risk weighting applied to it and give it a zero per cent risk weighting. Under Basel II it requires no capital at all because the regulators view it as risk-free. Under Basel III, I believe it has a very small risk weighting.
We see our service as a really good way of getting the capital benefits of using a CCP whilst still agreeing your trades bilaterally, exactly as they do today. When an agreed trade comes through to us from our customers, we are getting a transaction that has already been fully agreed between borrower and lender and all we need to do is to check that both parties have actually booked a matching transaction against each other and then forward it onto the CCP for novation and subsequent processing.
SLT: So as far as you’re concerned, the post trade process begins immediately after the point where the two parties agree the trade?
Perry: Exactly. The two parties agree a trade in the market exactly in the same way as they would now. There’s no difference at all. They book it in their systems in exactly the same way as now. It feeds down to Pirum and if they have indicated they wish this transaction to be put through a CCP, we will then match that transaction. It’s a trade that’s already been done though - what we’re doing is saying ‘I can see that trade reference ABC on your side is the same as reference 123 on the other and you have agreed on the terms of that trade - the quantity, the rate, the dividend, everything’. We match it and then send it off to the CCP, in our case Eurex Clearing, who then novate it after successful validation.
SLT: Doesn’t that make you a broker in some way, even if on an execution only basis?
Perry: No, we are not a broker because the trade has already been agreed. We’re just messaging it. We are saying the borrower is matched against the lender, they agreed the trade between them. We didn’t agree the trade and weren’t involved in agreeing it. What happens is the two parties separately inform us that they have agreed this transaction. And we check and verify that what they have entered into their systems is the same on both sides, so we have a matched and agreed transaction. We then send it off to the CCP who then novate the transaction and replace it with a trade between the borrower and the CCP and a second trade between the CCP and the lender.
SLT: So it creates a new transaction?
Perry: We are notifying the CCP of the decision of the counterparties to trade with each other. The point is we are not a trading platform and we are not an MTF where what comes in is demand and supply and you work out who is going to trade with whom. What we see is a transaction that has already been agreed, the terms are done, both parties are already identified and the trade is already booked into their systems - everything is already done at the point we come in. They are using us as a communication channel to get the trade into the CCP.
SLT: Do both counterparties need to be Eurex Clearing members?
Perry: They do. Both will have a direct contract with Eurex Clearing and we are simply facilitating matching and communication. We have connections to lots of different market participants and we have a matching platform that we use for real time contract compare and other post-trade processes that means we can identify transactions that have been agreed by the parties, booked on their systems and then we can send it through to Eurex Clearing for novation.
SLT: Once the agreement has been made, do the counterparties have any direct contact with Eurex Clearing regarding that trade?
Perry: Pirum is the channel for entering all normal life-cycle activities, for example returns or rate changes. We are taking the place of a trading platform as a “flow provider”. We view our processing with the CCP as purely a post trade function. In effect, we are offering a service which enables a CCP to be used as a systematic ‘put through’.
What is completely unique about what we are doing is that we think it’s very important to integrate the CCP novated transactions with all the other bilateral trading the firm is doing. CCPs are never going to cover 100 per cent of your business and firms don’t really want to have one set of processes for dealing with a CCP and a completely different set of processes for dealing with bilateral business. So given Pirum already has a lot of automation in the bilateral field, as we bring in the CCP option, we can make it look as much as possible just like another bilateral counterparty.
The existing trading mechanisms, the trading automation and the bilateral relationships and all of the ways counterparties currently do trades stays the same. They then can have all those transactions novated by a CCP - there’s no need for further integration for firms already integrated with us, they get this upgrade in being able to put trades through the CCP included as a piece of value added technology we offer. And then there are the benefits of all the operational efficiencies as a CCP will appear as one of the best automated counterparties on the Pirum platform.
SLT: What is the timescale from when the trade is agreed to it being actioned by Eurex Clearing?
Perry: It’s based on near real time feeds so it will be minutes. Our clients send us feeds on a 15-minute cycle so as soon as we get it and process it, if it matches with the counterparty we’ll send it to the CCP. It has to flow through quite a few different links to get to completion.
SLT: One of the criticisms of CCPs has been that it takes the relationship aspect away from the business. But with this model, the relationships remain key. But CCPs are still coming under fire for increasing the cost of doing business?
Perry: You retain the relationships and still get the benefits of trading via a CCP. This is a cost-effective service as we are not going to be charging a trading platform-type fee for what we do. We see this as part of the value-add of the post trade automation we offer.
What I think is very different from all of the other platforms is the post trade integration. You need this integration to automatically process CCP marks, rate changes and for returns to flow through automatically. Typically, other platforms offering CCP cleared transactions haven’t necessarily had that same level of integration. I’m very hopeful that the market is going to find this service gives all the benefits of CCPs without so much upheaval.
SLT: What’s the anticipated timeline for implementation?
Perry: The system was launched technically on 21 November, which means that clearing members can start doing simulation testing and evaluating the capabilities of the system. It’s not actually live at the moment, there is still work that market participants need to do in terms of testing their own systems. Initially Eurex Clearing’s offering will cover securities lending in German and Swiss main indices with cash and non-cash collateral including tri-party collateral services. There is automatic processing of mandatory corporate actions, with voluntary corporate actions coming later next year. Further extensions are planned in terms of coverage of European equity markets and Fixed income securities.
SLT: How do beneficial owners fit in?
Perry: Eurex Clearing has a specific lender licence model for beneficial owners. One of the issues for lenders in other models is that in order to have exposure directly to a CCP, you need to be a clearer and provide margin. This lender licence means a beneficial owner can be a clearer directly at the CCP and can therefore they have direct exposure to the CCP. In addition, they don’t need to provide margin. The collateral for the lender is held in an account at the CCP pledged to the lender but because it doesn’t flow all the way through in terms of transfer of title to the lender, the CCP doesn’t see any risk of not getting the collateral back. That’s quite a unique selling point.
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