--New EU regulatory regime could ease customer challenges in
case of a default
--Increased compliance, funds segregation costs to make trading
more costly, LME's Spanner says
--LME's Spanner expects clearinghouse launch in mid-2014; no
deal yet to leave LCH
This week's arrival of a ramped-up European regulatory regime is
set to make derivatives trading more costly for exchanges and their
customers, though it isn't clear by how much, the chief of the
London Metal Exchange's under-construction clearing group said.
"There's a price to be paid for extra regulation," Trevor
Spanner, an LME managing director and architect of LME Clear, told
Dow Jones Newswires.
Mr. Spanner said his team was still working out how much
compliance with Europe's new derivatives regulations, set to take
effect on Friday as new technical regulations are phased in, would
cost customers of LME Clear after the clearinghouse's launch. A
final date hasn't been set, but Mr. Spanner said LME Clear would
likely be operational in mid-2014.
Clearinghouses are the backstop of the multitrillion-dollar
futures industry. When two parties agree to a derivatives contract,
that trade can be "cleared" by a third party. This company, the
clearinghouse, effectively becomes a counterparty for both sides of
the trade, guaranteeing that it will be settled even if one member
defaults.
As a behind-the-scenes service, derivatives clearing was largely
overlooked by regulators and market participants alike until the
2008 financial crisis.
"The boring pipes and drains have gone from being a fairly
backroom activity to, in many cases, being on a CEO agenda," Mr.
Spanner said.
Clearinghouses drew increased attention after the 2008 crisis as
regulators sorted through the global financial system in search of
potential trouble spots. Scrutiny was further heightened with the
collapse of futures-industry giant MF Global in October 2011 and of
U.S. brokerage Peregrine Financial Group less than a year
later.
As MF Global and PFG disintegrated, some of their clients
complained about facing a backlog in closing or transferring their
positions, and in having the cash in their trading accounts
returned to them. In some cases, these investors lost money because
they were unable to quickly act on their positions after their
brokers defaulted.
The European Market Infrastructure Regulation, a revamp of
Europe's derivatives infrastructure, clarifies the rules on
customer access to their funds and the transfer of positions in the
event a clearing member gets into trouble.
Under EMIR, clearinghouses are required to hold
clearing-members' customer cash in segregated accounts. Analysts
say that will lead to an increase in the amount of collateral
exchange customers must post. The cost of operating a clearinghouse
is also likely to rise, Mr. Spanner said, because of more-stringent
trade reporting and personnel requirements.
EMIR rules are also slated to force the trading of some
privately negotiated, over-the-counter derivatives products, to be
routed through a clearinghouse. The goal is transparency and a
better accounting of risks to the financial system, and it will
also mean a new business for clearinghouses.
The LME's move to build its clearinghouse follows similar
efforts by rivals IntercontinentalExchange Inc. (ICE), CME Group
Inc. (CME) and NYSE Euronext's (NYX) Liffe as the exchanges sought
the income from clearing trades and greater control over new
products. LME currently clears through LCH.Clearnet, Europe's
largest independent clearinghouse and a takeover target of the
London Stock Exchange Group PLC (LSE.LN).
Increased regulatory costs aside, some market watchers have said
that an LME-only clearinghouse would likely require more cash from
member firms to capitalize than the LCH required. LCH traded a wide
range of non-metals commodities, as well as equities and other
products, giving it a larger pool of collateral to work with.
Mr. Spanner said worries that LME Clear's customer costs would
be higher than LCH were unfounded. "There's not as much
cross-asset-class synergy as people would widely believe."
When the LME said it was exploring building its own
clearinghouse, the exchange estimated LCH took in more than $6
million annually in fees to clear LME trades, and earned "a
multiple of the clearing-fee income" on investment returns
generated by collateral.
Mr. Spanner declined to comment on his expectations for how much
LME Clear would earn, only saying the house would be profitable.
LME contracts worth about $14 trillion changed hands, which,
according to exchange calculations, accounts for more 80% of the
global base metals futures trade.
Mr. Spanner said his team, which would eventually employ about
40 people, would focus on the rollout of LME Clear first, before
exploring potential partnerships with other exchanges or new
product offerings. But he said LME Clear would play a major role in
the ambitions of parent Hong Kong Exchanges & Clearing Ltd.
(0388.HK), which outbid CME, NYSE and ICE with its $2.2 billion
purchase of the LME last year.
Mr. Spanner said the LME hadn't yet made arrangements to
terminate its contract with LCH.
"The actual transfer needs to be very carefully coordinated,"
Mr. Spanner said. "There needs to be a Plan B."
What could go wrong? When ICE was bringing online its European
clearing operation in 2008, the exchange scheduled the handover of
customer positions from LCH for the third Monday in September. When
it became clear that Lehman Brothers would collapse the same day,
LCH aborted the handover.
"We have to plan for that," Mr. Spanner said.
Write to Matt Day at matt.day@dowjones.com
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