News: ESMA CCP front-loading - problem waiting to happen? | Risk article25 October 2013 | Jon Skinner
ESMA rules deem that once one CCP is authorized to clear a given product, non-exempt participants have to clear every trade executed after that date - even if the clearing mandate for new trades is not live yet. Participants can either clear the trades immediately on execution or more likely by catching up or "front-loading".
In the US, the CCP mandate came in with pre-mandate trades exempted. Thus it has continued to be true that both parties know at the point of trade whether the trade will be cleared and which CCP they will be cleared at. Even the SEFs carry differential prices per CCP and a major effort has been undertaken to maintain clearing certainty at the point execution via Triana and Markit credit checking hubs. There has been elective backloading but once again parties are aware of the economics of this at the time.
By contrast, the ESMA front-loading rule creates point-of-execution clearing uncertainty on whether a trade will be mandated and which CCP it will clear at which can only challenge swap pricing / liquidity in the intervening period. See Risk article: CCP frontloading: the pricing nightmare (subs. required) for a full elaboration of the pricing problem.
The gist is that CSA VM currency terms vary between bilateral and CCPs and portfolio IM cannot be predicted without knowing the CCP and the portfolio risk profile at the point of clearing the trade. In effect there will be an unquantified contingent unrealized P&L item building up for participants during the mooted intervening period.
Not to mention the sheer operational / legal effort around bulk loading of trades which neither participants nor CCPs are very well set up / automated for.
All of which begs the question - why not just exempt until the mandate goes live as per the CFTC approach?