News that Chi-X Europe and LCH.Clearnet are set to go live with their centrally-cleared service for Contracts-for-Difference (CFDs) on FTSE 100 stocks today is a sign of the times.
As we discussed in our September 2010 report “Centrally-cleared CFDs -- A Buyside Perspctive,” the concept of moving CFDs into a central clearing counterparty (CCP) model isn’t new to the UK. But the fact that such a service is only now coming to light is in part due to a desire from regulators to see market-led solutions to impending derivatives reform.
The EU has proposed mandatory CCP clearing for eligible OTC derivatives. To determine eligibility, regulators have introduced a 'top-down/bottom-up’ approach whereby they will force OTC derivatives into clearing based either on their own findings or on demonstration by a CCP that clearing is possible.
The fact that the UK’s Financial Services Authority (FSA) has given its blessing to the LCH.Clearnet initiative is the first real demonstration that regulators would rather endorse bottom-up approaches instead of imposing top-down mandates.
Admittedly, CFDs weren’t in the crosshairs of the regulators when they drafted the reforms – the equity derivative markets behaved impeccably during the financial crisis and showed no signs of systemic risk. And the fact is that LCH.Clearnet was working on the concept long before the financial crisis even started, which is why they have stolen the march when it comes to seeing which new derivatives will move into a CCP model.
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6 Comments to "Regulators OK with Market-Led Derivatives Reform":
paulconstantino
11 January 2011
I am wondering how this model can compete with a bilateral contract that allows for cross-margining. It would seem to have higher associated exchange and margining costs.
Comments (21)
williamrhode
11 January 2011
A popular bone of contention Paul. As you correctly identify, prime brokers argue the point well that cross margining already occurs with a high degree of efficiency in the OTC market. But its a pretty exclusive world, dominated by the large hedge funds and the large prime brokers with access to a lot of stock inventory. For the rest - retail aggregators, long only AMs, UCITS III compliant funds, who may want to play - this is not a world they can easily access. In essence then, this new service opens up the CFD world to a broader audience. Consider it a low cost alternative to what has hitherto been a premier service available only to the few. And to some extent the competition point may become moot now. If regulators mandate that CFDs are eligible for clearing, then all will have to adhere to the new rules, regardless of relative efficiencies between models. Finally, it should be noted that while there will be clearing costs there will not be an exchange listing for this service and thus no exchange fees.
Comments (88)
paulconstantino
11 January 2011
These are good points William and I would add that the world is changing in the Prime Services space as Clients look to diversify their counterparty risk, especially considering their exposure to Lehman, Bear Stearns, etc. In light of this, new participants are emerging in the prime space and implementing technologies to cover these and other risk mitigating products such as portfolio swaps. Some of these new participants are specifically targeting HFT Clients with lower AUM that would necessarily preclude them from Tier 1 Prime Brokerage coverage. Consequently, unless there is a mandate, those looking to take CFD/Portfolio Swap exposure including the cross margining benefits may have the opportunity in near future.
Comments (21)
williamrhode
11 January 2011
Yes, I have started to hear about these new OTC initiatives, though I've yet to learn the details. I believe a sub-committee at ISDA is helping to co-ordinate in some way? Its encouraging to see the market responding to the changes so pro-actively. Ultimately, this will benefit the end-user/consumer, with lower costs, better technology and more competition between providers.
Comments (88)
miller
11 January 2011
I would like to understand thoroughly contracts for difference. Can you point me to a source?
Comments (5)
paulconstantino
11 January 2011
Try http://www.cfo.com/whitepapers/index.cfm/displaywhitepaper/10509151?topic_id=10240241 to start...
Comments (21)