Article: Indirect Clearing. Can it work?

25 September 2013 | Maria Leontiou

As EMIR moves forward to its next milestones, central clearing, one of its major pillars (if not the core of EMIR) , is the next big challenge for all of us, assuming that trade reporting is already analysed and now in a testing phase.

In order to facilitate the use of central clearing, EMIR recognises that contracts can also be cleared through “indirect clearing”, i.e. that counterparties who are not themselves clearing members can use the services of CCP members to meet their clients' requirements which is really important, as for many counterparties, which are subject to a clearing obligation but unwilling or unsuitable to become direct clearing members or direct clients of clearing members, indirect clearing will be the only option available to satisfy their clearing obligation. However, it should be noted that it is not a mandatory obligation on clearing members to provide indirect clearing services.

Several concerns arise with regards to indirect clearing, one of which is expressed by Daniela Russo, director general payments and market infrastructure at the European Central Bank (ECB), quoted in Risk's article yesterday saying that indirect clearing model needs work and that Regulators need to provide greater clarity on the capital treatment of it.

"Indirect clearing and the concerns of banks have probably to be addressed by banking regulation. But definitely, I agree this is an area where it would be good to provide clarification on both the risks to be addressed and the implications for capital charges with a view to creating the right incentives," says Russo.

But this is not the only thing to consider, If indirect clearing is ever to work in practice.

  • Should the Clearing Members decide to provide indirect clearing services, they need to be on reasonable commercial terms.
  • CCPs need to prove that they have the means to identify and deal with indirect clearing relationships conducted through the clearing member following a clearing members´ default. This of course will depend on the segregation solution applied.
  • Clearing members who will facilitate indirect clearing, and clients through which indirect clearing will be carried out, should ensure that they are able to port indirect clients’ assets and positions to an alternative non-defaulting clearing member.
  • Clearing members must have in place procedures for managing the default of an indirect clearing member and its clients. The procedure adopted would depend on the degree of protection provided to the indirect clearing members' clients.

As per Goldman Sach's comments on the discussion paper on OTC Derivatives and CCPs prior to RTS issuance, "The existing use of indirect clearing arrangements involve a degree of counterparty risk, as does a direct clearing relationship. If the use of indirect clearing arrangements imposes a higher barrier to entry than a direct clearing relationship, then it will not be viable".

As per my post on 29 August 2013, LCH has already published a document on their indirect clearing offering. Check page 9 of the aforementioned document.

Maria L.



Indirect Clearing. Can itwork?

Never believed this would work simply because the non-clearing member facing the end client is getting most of the commercial benefits of clearing whilst passing on most of the costs (e.g. default fund contributions and associated capital) to the clearing member. For a commercially reasonable arrangement to be possible the clearing member would be looking to be paid more than a direct client would pay it and at the same time the end client would be looking to pay no more than it would pay to clear direct via a clearing member. Effectively the non-clearing member would have to pay for the privilege of doing this rather than earning revenue from it. That's a high price to pay for trading client retention which anyway is not proven...