Clearing brokers send balance sheet allocations to Basel

Data including the balance sheet allocated by several banks to their over-the-counter derivatives clearing brokers and the amount of margin being received by clearing brokers has in the past few weeks been sent to the Basel Committee on Banking Supervision for its consideration.

The calculations are understood to show the impact of the leverage ratio on a clearing broker under its current calibration and how much capital would be required if clearing brokers were able to use margin as offset.

Privately, regulators are calling for this kind of data. A source close to the Financial Stability Board (FSB) says it recognises a lively debate between domestic authorities calibrating the current leverage ratio but that numbers and clear evidence will be needed to demonstrate the ratio's causal link to the retreat of banks from the clearing space.

The FSB source says: "If people can show us the numbers and give clear evidence that the putative retreat of banks from this business is directly linked to some of these concerns then [regulators are] more than happy to engage with those sorts of concerns. But part of the problem here is that there is a lot of noise and people find it hard to produce numbers and say here is clear evidence, this is what is going on."

The leverage ratio remains subject to ongoing evaluation by regulators who are considering whether they have got the balance right in the way capital rules are calibrated. Last week, the European Banking Authority said it will incorporate additional analysis into its calibration reports on proportionality, the scope of application and impact on markets of the leverage ratio and net stable funding requirements developed by the Basel Committee.

The global head of clearing at a large New York-based bank that took part in the data pooling exercise says that while some of the information provided to the Basel Committee might already have been in the public domain – such as segregated margin – the balance sheets associated with particular clearing brokers would not.

The head of clearing says: "What data wouldn't have been in the public domain provided to the Basel Committee would have been the capital associated with each business, because that's very much based upon how different firms allocate capital down to different lines of business."

They add: "There does seem to be optimism that regulators will tweak the leverage ratio to reflect that clearing agents collect margin in the form of cash or securities and that is always held in a segregated account and it cannot be used to lever up our own balance sheet so we should get the benefit of that margin as an offsetting to the potential future exposure. Secondly, if margin is received in cash that is a balance sheet item and counts in the leverage ratio. It's not cash we can use to lever our own balance sheet, so shouldn't be considered an on-balance-sheet item."

Collection of the data, including on and off-balance sheet margin, was co-ordinated in New York and delivered to the Leverage Ratio Working Group, which undertakes the technical work associated with the leverage ratio within Basel III.

Citi and UBS are among those who have changed their accounting practices to move client margin off balance sheet – a practice currently being examined by the US Commodity Futures Trading Commission (CFTC), says the head of clearing in New York.

A spokesman for the Basel Committee says that, in order to inform its policy-making process, it is currently collecting data from various sources on the issue of client initial margin for centrally cleared client derivative transactions.

The spokesman adds: "This includes a comprehensive data collection on the composition of client initial margin in parallel with various options on the Standardised Approach for Counterparty Credit Risk (SA-CCR) for calculating counterparty credit risk exposures for derivative transactions through the semi-annual Basel III monitoring exercise/quantitative impact study (QIS). The analysis on the latest QIS exercise based on end-June 2015 data will be finalised by the end of this year."

Future of clearing

A report written by the FSB and published in July under the auspices of the International Organization of Securities Commissions, titled Review of Implementation Progress in Regulation of Derivative Market Intermediaries, noted that several authorities have highlighted the need to consider how a range of international regulatory requirements facing central counterparties (CCPs) and banks may have an impact on the availability of central clearing.

In particular, the report says: "These authorities note that it is important that requirements operate in concert to meet the policy objectives related to increased uptake of central clearing of OTC derivatives, while at the same time supporting the resilience, recovery and resolvability of CCPs and enhance the resilience of banks."

As clearing has become a more expensive business to operate, a number of banks have adjusted or exited their offerings. Goldman Sachs and others have hiked clearing fees, while Nomura is shutting OTC clearing in the US and Europe, joining BNY Mellon, RBS and State Street in bowing out.

According to CFTC data, in January 2008 there were 151 futures clearing merchants (FCMs), but by January 2012 that number had dropped to 116 and by January 2015 only around 74 FCMs were active.

David Escoffier, deputy head of global markets at Societe Generale and chief executive at Newedge, says various reforms – both proposed and enacted – have pushed OTC clients towards a cleared model while the economics are flawed for clearers, with result being ongoing concentration in the industry. The top five US swaps clearers, for example, have 73% of the business.

One New York-based head of derivatives at a leading US bank says: "We are in a really interesting position right now. Conflicts in regulation are compelling more risk in the system. The biggest issue is the concentration we are seeing amongst clearing members – they're dying out. There's a reason for it and we really need to understand why. We are very hopeful that regulators take action before more people get out of the business or fees skyrocket."

Christian Lee, head of the clearing, risk and regulatory specialist team at London-based consultancy Catalyst, says the continuing delay of the implementation of the clearing mandate in Europe means that client volumes have yet to arrive. Many clearing brokers whose business plans were predicated on the mandate arriving at the same time as the US or Japan found their financial projections undermined.

"The clearing brokers have an understandable gripe with the European regulators with this procrastination," says Lee.