Unlike future exchanges which each clear in a single CCP – often owned by the exchange – OTC CCPs are developing in a way which allows trade executions from multiple channels and venues to clear in one place. This has promoted a multi-CCP world where CCPs compete to clear the same products – as regulators and legislators hoped.
Full CCP interoperability, however, has remained a background topic as the initial mandates for clearing and trading unfold. Full CCP interoperability allows two sides of the same executed trade to clear in different CCPs (i.e. each participant can choose their CCP independently of the other) The diagram illustrates:
As set out below, the benefits are clear and the challenges look surmountable but will regulators push this form of interoperability? So far in the US, Dodd-Frank omitted interoperability entirely though the DoJ has done some preliminary investigations. In the EU, EMIR includes interoperability but it is not clear (to me at least) whether ESMA intends to push this form.
I am interested in views on the case below for full interoperability and whether ESMA or the DoJ intend to pursue it.
1. Systemic CCP risk de-fragmentation. CCP fragmentation is a considerable demerit of a multiple CCP world and would largely be eliminated by allowing each participant to directly consolidate it’s CCP risk in fewer chosen CCPs per asset class (ideally one globally) and maximize risk netting benefits in the process.
2. Simplified / more liquid trading. DCM / SEF / voice-block participants would not need to specify CCP at the point of trade and would get a single quote rather than a quote per CCP.
3. Reduced CCP funding and bank capital required. This is a consequence of reduced risk and possibly the ability to be more selective in CCP membership required.
1. Inter-CCP trade portfolio handling. These require specific operational processes, legal and regulatory framework (especially if across jurisdictions) and bespoke risk management / margin methodologies. Whilst this shouldn’t be underestimated, at least for two CCPs within a single jurisdiction this ought to be achievable.
2. CCP to CCP contagion. Regulators might fear that the default of one CCP could ripple to other CCPs directly. Despite considerable notionals in the inter-CCP portfolios, risk netting benefits and the implicit protection of each CCPs existing financial safeguards should keep the level of risk and margin in check.
3. Persuading rival CCPs to work together. Likely one or other CCP could see competitive demerits of doing this: hence the need for regulators and market participants to drive this initiative.