Systemic Risk in Clearing Houses - an Oxymoron?

Clearing Houses have been a fundamental industry component for decades. Indeed the advent of computers and databases enabled the finance industry to consolidate its risks and costs bringing economies of scale and increased capacity for financial services firms. However, clearing houses all grew from vertical business models based around different products and market sectors. The development and growth of derivatives increased the value and dependency of Clearing Houses to individual Financial Services firms and the finance industry as a whole. But times change, as do markets, regulations, technology and customer needs and the old fashioned Clearing House model has been put under extreme pressure, to maintain and improve service levels.

The questions about the future of Clearing Houses are profound and it's vitally important that the financial services industry, globally, find answers to the many problems that confront the Clearing Houses but that also impact each and every firms' operations.

Interoperability between Clearing Houses has once again hit the newswires with an increased level of zeal being given to making it work. The FSA has given the green light for LCH Clearnet and X-Clear to move forward with their connectivity. However, this is only a modest move forward. As so many of the Clearing Houses have for years put in place agreements that have failed to activate implementation and progress has virtually stopped.

The concerns appear to be mainly on systemic risks that could arise from interoperability and on the face of it, this is a valid point, but an important basis of using a Clearing House is to reduce risk! It appears that the regulators and some parts of the industry have created an oxymoron situation.

Yes, there would be systemic risk but surely this should be covered by ensuring first class collateral, priced to the second and topped up with sensible margin calls from clearing house members!

Interoperability in itself is a very bad business model for Clearing Houses, as it opens up the opportunity for them to lose business to competitors, who can price aggressively and manage efficiently collateral and margins. A Clearing house works best for the industry, if it is singular. The combining of assets and the cross industry management of assets brings efficiency and benefits to all (See DTCC impact in the USA). Competing Clearing Houses as a tool to bring down costs and risks appears to be also an oxymoron!

All these points and many more will be debated at the Post Trade Forum on the Future of European Clearing Houses on the 23rd June hosted by the London Stock Exchange.