Buy-side firms should begin testing over-the-counter derivatives clearing services as early as possible to avoid getting trampled in a last-minute stampede, according to senior industry participants at a recent webinar hosted by Risk in New York.
Regulators are keen for a broad array of OTC derivatives products to be cleared, but market participants argue less liquid instruments will be difficult to load on to CCPs.
“Right now, half the market is playing in the plain vanilla space. The question is what’s going to happen to the other half, in terms of options, swaptions [and] less liquid products. I think that’s less certain,” said Converse.
One of the toughest areas for regulators implementing Dodd-Frank is the extent to which client assets should be segregated from each other at the dealer level. Last November, the CFTC proposed four different approaches, including the model currently operated in the futures market. But buy-side firms have come out in favour of the so-called legally segregated operationally commingled (Lsoc) model.
Jack McCabe, co-head of the global futures and derivatives clearing group at Goldman Sachs, said the bank was supportive of this mechanism. “We’re certainly supportive of that approach – we think it provides a good compromise between what our customers want, which is segregation and portability, but also the ability to operationally manage the segregated pool, which is a much more efficient approach for us.”
Nonetheless, it could carry additional costs for buy-side firms compared with the more traditional futures commission merchant model, he noted. “There could be somewhat higher margin requirements from the Lsoc approach, depending on how the clearing house deploys its stress test, and that is something clients will have to think about,” he said.
Compared with other buy-side firms, hedge funds were most familiar with the process of posting margin, meaning they are likely to be among the early adopters of clearing, said McCabe. “Hedge funds will be early adopters here, because in most cases they already post initial margin. They have a smaller number of accounts and less infrastructure to change compared with the large asset managers,” he said.
For firms that were less familiar with posting margin, panel participants said the use of CCPs was likely to have a noticeable impact on liquidity risk management.