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Swap Clearing: an Inconvenient Truth

This week’s International Financing Review reports that BNY Mellon is closing its swaps clearing service, a mere three years after its inception.

“We are exiting the derivatives clearing business in the US due to market and regulatory factors that will limit our ability to grow the business in the future,” said a spokesperson for the bank.

The move comes just nine months after the imposition of mandatory IRS\CDS clearing for Category 1 entities and highlights concern among regulators that prohibitive costs will act as a disincentive to clearing market entrants. Balance sheet intensive, technologically daunting and operationally complex – the clearing business faces huge challenges with only a limited return in prospect.  BNY Mellon, although by no means an established clearing operation along the lines of L.C.H. Clearnet or CME Group, is a significant market player and their withdrawal at a relatively early stage doesn’t augur well for diversity in the clearing market some years hence.

Complaints and regulatory concerns are by no means limited to the clearing sell-side. The PRA’s 29th November decision to allow offsets of variation and initial margin, effectively cutting the leverage exposure calculation by half, was explicitly motivated by their perception that prohibitive costs may act as a disincentive to clearing. On 7th December the SEC raised buy-side hackles by extending a temporary rule that allows FCM’s to use portfolio margining. The extension until 31st January 2014, places an increased capital burden on the buy-side, effectively subsidising clearing members.

The clearing regime is still in its infancy- to date it seems to be pleasing no-one, the firms running it aren’t making much money despite its customer’s complaints as to expense, and the regulators are concerned for the viable participation of both. The clearing structure is too vital a part of the new reforms to be materially revised at this stage. It is likely that further concessions will be made on margining costs, thereby quietening the buy-side, and as the market continues to coalesce round a few dominant clearers, profitability will incrementally improve, although perhaps at the expense of competition.

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