Following last week’s WFE IOMA conference, Eric Müller shares his viewpoints on the clearing and derivatives landscape.
The IOMA conference brings together the leaders of the clearing and derivatives industry each year, to debate the themes impacting the sector. As co-host in Frankfurt earlier this month, what are the key global trends on your radar?
One thing that’s on everybody’s mind right now, is of course the Brexit decision, which was a shock for many in the UK financial industry but equally in the European Union. The uncertainty created by this political event is widespread and requires all market participants to plan ahead.
There’s no doubt that continental Europe will have to continue its close cooperation with the UK, the rules applicable to international markets and to competition do not change overnight. But these rules call for new, more intelligent solutions to prevent imbalances.
We can see that major political events with the potential to create a seismic shift – another example is the French elections – are driving investors towards exchange traded derivatives, which offer more resilient and robust liquidity. So, the trend from OTC to exchange-traded derivatives continues in this way.
In addition, concentration of client risk in a limited number of risk-taking entities remains a challenge for systemic stability in crisis situations. Therefore, new, more direct models will become more important. To address this need, since summer 2016, buy-side clients can become direct participants with our clearing house via our ISA Direct model, which allows them to significantly reduce their counterparty risk.
Since the beginning of 2017, swap volumes at Eurex Clearing have grown by more than 30%, demonstrating the continuing growth in demand for clearing OTC derivatives. Can you tell us about the factors behind this?
Over the last couple of months, demand for clearing services for over-the-counter derivatives, like swaps, rose significantly. This brings the G20 closer to their objective of strengthening the stability of the financial system by central clearing of as many transactions as possible.
At a time of rising regulatory requirements and continuing geopolitical uncertainty, we work on delivering attractive and efficient solutions which we build out in a process of ongoing dialogue with our customers. We continue to see great interest from financial institutions as they search for efficiency and stability for their businesses. An example is KfW, Germany’s largest promotional bank and a leading public sector institution, which is exempt from the EMIR requirement to clear standardised interest rate swap contracts. Despite that exemption, the bank has decided to clear voluntarily in order to increase the settlement efficiency of the transactions it uses to hedge against interest rate changes.
The financial regulatory agenda for the past ten years, post-crisis, has been clear. Do you believe that recent events have possibly changed the direction of regulatory travel?
It is crucial to recognise the progress made in the EU regarding financial market regulation and supervision in the past years. However, what once started out as a coordinated approach has now been taken over by new realities that have led to regulatory inconsistencies in some areas, like derivative markets regulation. One example is the decision-making process on CCP equivalence.
Despite significant progress towards the European single market, capital markets are still fragmented. The political uncertainty generated by recent events, such as the British referendum and the US elections, emphasises the need for further European integration. The decision of the UK to leave the EU leaves many questions regarding the evolution of financial regulation, market access and the future of the Capital Market Union up in the air. The intention of EU’s largest financial market to leave the EU therefore increases the need to accelerate the CMU project for the remaining EU-27.
The resilience of CCPs was proven during the financial crisis; indeed, their systemic importance cannot be overstated. How do you ensure the resilience of your CCP day after day, trade after trade?
We comply with high standards regarding our governance and incentives, risk management, liquidity management, and our operations. Stress tests are also conducted on a regular basis and are key to the safety of our operating processes.
24 June 2016, the day following the British Referendum, showed how well our systems work. The Brexit decision triggered a sharp increase in selling and buying activity and volatility in financial markets escalated rapidly. At Deutsche Börse, our trading systems’ stabilisation measures worked well. In the post-trade layer, the smooth functioning of the markets was facilitated by Eurex Clearing. Real-time risk management and advanced risk protection worked for our clearing members. Intraday margin calls allowed us to quickly respond to increased price volatility and the growing positions of clearing members. All intraday margin calls were met by our clearing members, and there was active risk management of all member portfolios.
This shows that European safeguards worked well in times of market stress and heightened volatility. The same could be observed during the US elections.
How will the role of CCPs evolve over the coming years?
Over the coming years, CCPs will become even more important. All the advantages of central clearing lead to greater safety and integrity in the financial markets. As both are objectives which market participants have in common, we expect further demand for our services.
Once Emir is fully implemented and all phases of the clearing obligation have been rolled out, there will be increased regulatory-driven demand. However, already today many market participants clear their trades voluntarily to benefit from our offering. In addition, new legislation is coming, like the CCP recovery and resolution regulation, that will further enhance and strengthen our role in the financial markets.