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News: ESMA CCP front-loading - problem waiting to happen? | Risk article

25 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?  


Comments

Actually the dealers probably would like to clear Swaptions to reduce bilateral Basel 3 RWA. The question is whether it is sound to put nonlinear risk comingled with linear risk in a CCP given nonlinear pricing factors can be patchy in a crisis....

The regulation refers to the products that are authorized to clear; let's suppose CCP xyz starts clearing swaptions and CFTC approves it, then swaptions become a product that is mandatory to clear. Such situation creates operational headaches from dealers point of view so there will be a push from them to delay the clearing of such product.

That's what the Risk article says. Not my own view and what you suggest would be more logical.

"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. "Are you sure about that? Surely until the mandate to clear kicks in, authorisation of a CCP merely maintains the existing status quo.

I see now - it's "front loading" - swaps being caused to be cleared retrospectively from the date of a CCP authorisation, once mandated. Dealers are well confused - do you clear them and take the consequences now, or leave them uncleared until the mandate kicks in - hence the pricing dilemma. The price is quite different outside clearing due to CSAs and discount rates, than inside clearing, so what do you do in this twilight zone?

D2D linear is uusually cleared anyway so its about C2D. Cleared is more.certain but client may not be ready and it may cost one.or both parties more....

...assuming the d2d hedge will clear it would be cheaper for the dealer to clear the c2d trade.:..