Extending Central Clearing to New Asset Classes

The advantages of central clearing are well known by market participants and regulators. The benefits clearly outweigh the costs when bilateral credit lines are short, or for those products that are subject to higher volatilities, such as equities and financial derivatives. The advantage of accessing central counterparties is twofold. On the one hand, participants will reduce their costs of capital by compressing their overall position into a single net exposure with one counterparty, the CCP. But in addition to this, benefits will come from the lower capital requirements of the exposures to CCPs. These two main reasons provide the logic for the understandable demand from participants and supervisors to promote the use of central clearing.

Moreover, there is also an interesting industry debate around the risks of concentrating central clearing with a few providers acting from a pseudo-monopolistic position. This has become especially relevant in Europe in the context of Brexit - it seems to be increasingly difficult to encompass political concerns with divergent market positions. The market visibly tends to concentrate liquidity and favour central clearing dominant positions. However, this not only results in a systemic risk issue, but also poses the real risk that alternative providers may end up being expelled from the market in what would become a de facto monopoly. Hence, regulators do have reasons to continue their endeavours to safeguard competition and ensure a level playing field in the provision of clearing services. A balance between the netting benefits derived from a full concentration, and the need to diversify central counterparty exposure risks must be pursued to ensure that systemic risk remains under control.

Looking at diversification from a business perspective, broadening clearing services towards new asset classes also provides interesting depth to this discussion. CCPs may focus on a single product to provide maximum netting and scale-economies, or alternatively they may opt to diversify their activities towards a broader range of products. The latter can, in our view, foster innovation to be worked into portfolio margining solutions where margin efficiencies across different products could then be achieved. In our experience, clearing several products by a single CCP delivers synergies for market participants in many dimensions, such as cost reduction, thanks to the streamlined communication, connectivity, interface automation and on-boarding processes. In addition, this will also bring global benefits derived from synergies taking place in the CCP itself by bringing services at lower fixed costs and leveraging the existing knowhow to implement top risk management and operational procedures.

Regarding asset diversification in clearing, we must also refer to the recent consultation launched by the European Commission for the review of the European Clearing Framework. This consultation, launched in the context of Brexit and the political discussions around clearing, already points in the direction of a possible expansion of current clearing obligations towards a broader range of products and participants. We cannot affirm that all products will be suitable for central clearing, and we are aware that the clearing obligation derived from the 2008 crisis has already achieved a major volume of OTC derivatives being directed towards CCP clearing. Thus, the main remaining focus around traditional assets seems to be with regards to products that have been deliberately left out of this clearing obligation so far, for example in relation to FX derivatives and in the REPO business. These two markets are critical for supporting the real economy and should be handled with care. However, access to REPO clearing by financial counterparties is no longer an issue in our view, and the choice on whether to clear or not is mainly driven by risks, costs and spreads. Consequently, we do believe that the market is ready for a progressive move towards certain obligations for REPO clearing. We should also mention the key role certain public institutions play in the REPO business - active participation of these institutions would certainly help to drive liquidity into the CCPs.

The biggest challenge for the industry will come, however, from digital assets. Spot and derivatives business on crypto assets is growing very fast with the involvement of new incumbents that are not subject to prudential, transparency, anti-market abuse or AML regulations. The crypto derivatives market reached a peak of almost 5 trillion USD in 2021. Market infrastructure providers are now trying to move fast to deliver regulated, transparent alternatives to investors in digital assets. As the underlying asset is not regulated, market infrastructure providers can only provide services on derivative products. Those crypto derivatives that can be traded in regulated markets and MTFs are subject to the central clearing obligation. However, OTC crypto derivatives are not, unless explicitly covered by future regulation. SIX joins the wider industry push for these kinds of assets, and the services provided around them, to be regulated as soon as possible to ensure a level playing field between new and traditional providers. In the meantime, we should be pushing for OTC derivatives on crypto assets to be subject to the clearing obligation, in line with the rest of OTC financial derivatives.

In summary, there are exciting times ahead, where conflicting forces will be shaping the future of the clearing industry. There are several key themes to watch - whether trends pushing the concentration of clearing will trump the need for competition, if future regulatory changes will achieve the objective of improving market stability, if an expansion of the clearing obligation will become an opportunity towards diversification or rather towards further concentration, or even if the digital revolution will become an opportunity or a threat to CCPs. For SIX, the next few years will see incremental developments across the clearing landscape, and we are excited to see how this unfolds.