Erik Müller: 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 Müller, CEO, Eurex Clearing, cited in this year’s GFF summit.
Müller explained that the objective “must be for buy-side firms, sovereigns and central banks, who are increasingly a client base for the CCPs”.
Discussing what makes a CCP useful and unique, Müller said: “It is the role of a risk manager in the financial markets and CCPs build a firewall if something bad happens in the financial markets.”
He also noted that there is an increasing number of asset classes that CCPs serve, such as repo, securities lending, and foreign exchange.
“Historically 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.”
“Market 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.”
Müller 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 Müller explained that the financial crisis revealed that the concentration and interconnectedness of the banks can prove to be problematic.
“It 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.”
“CCPs 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—a high degree of netting efficiency that is introduced to the system (95 plus percent).
Meanwhile, the second is the concept of variation margin. Müller noted that the CCPs mark to market the exposures.
“We don’t 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.”
“The 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.”
Müller continued: “Fourthly, 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.”
Fifth, Müller 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.
“These 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.”
Discussing Brexit, Müller stressed that Brexit is important in the CCP world. He commented: “In 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.”
Müller explained that the objective “must be for buy-side firms, sovereigns and central banks, who are increasingly a client base for the CCPs”.
Discussing what makes a CCP useful and unique, Müller said: “It is the role of a risk manager in the financial markets and CCPs build a firewall if something bad happens in the financial markets.”
He also noted that there is an increasing number of asset classes that CCPs serve, such as repo, securities lending, and foreign exchange.
“Historically 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.”
“Market 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.”
Müller 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 Müller explained that the financial crisis revealed that the concentration and interconnectedness of the banks can prove to be problematic.
“It 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.”
“CCPs 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—a high degree of netting efficiency that is introduced to the system (95 plus percent).
Meanwhile, the second is the concept of variation margin. Müller noted that the CCPs mark to market the exposures.
“We don’t 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.”
“The 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.”
Müller continued: “Fourthly, 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.”
Fifth, Müller 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.
“These 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.”
Discussing Brexit, Müller stressed that Brexit is important in the CCP world. He commented: “In 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.”
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