Whether “waiting for” or “fearing” are the right words can be debated, but we think that Eurex’s securities lending CCP model is set to be a major game changer. The differences between this model and other securities lending CCPs is that beneficial owners and securities lending agents can participate directly without a clearing agent, and that beneficial owners do not need to post additional margin if they already hold pledge-able assets with an accepted tri-party agent. These have been the stumbling block for other securities lending CCPs.
We looked at Eurex’s securities lending CCP model last September (“Eurex Clearing gets two key ingredients right for seclending CCP“). Here’s what we said then:
“According to a recent article by FS Research, Eurex’s new CCP service for securities lending makes the beneficial owner the relationship holder with the CCP. This puts a clearing bank out of the picture, unlike in the US where Dodd-Frank mandates that an OTC derivatives trading firm have not one clearing agent but two (one principal and one for back-up). As agent lenders maintain control of the account for their beneficial owner clients without having to share their data with a third party, this removes a key obstacle from using the service.
“Eurex has also worked it out to avoid beneficial owners having to post initial or variation margin for their securities loans over the CCP, instead allowing a pledge from a tri-party collateral provider.”
If ever a securities finance product was drifting towards the right regulatory tides at the right time, it is Eurex’s securities lending CCP. Regulatory interest in CCPs remains high and market participants are eager for the means to reduce their balance sheet and capital risk requirements. Of course, banks and brokers are being pushed toward CCPs by Basel III rules that give preferential 2% risk weights to trades cleared there, not to mention the expected margin differences for cleared vs. bilateral trades. While the regulatory rationale may be unwelcome, CCPs are increasingly seen as a better capital bet than bilateral trades for transactions where they are viable.
Securities lending stands to benefit from CCPs as much as other products under the new rules insofar as beneficial owners will accept them and securities lending agents benefit from them. A major trade-off may be in indemnification; a loan cleared on a CCP may be able to be conducted without indemnification. This would save the securities lending agent needed capital with no perceived detriment to the beneficial owner. In fact, the CCP guarantee appears duplicative to indemnification in assuring beneficial owners that they will get their securities back. Whether every market participant believes in indemnification or not, or the CCP guarantee or not, may take a back seat to the realities of capital charges and what banks are willing to commit to their securities lending programs. Eurex’s CCP gives the added benefits mentioned above of no new margin and no clearing agent required.
We are very interested to see how Eurex’s model goes in Europe. We would be even more keen to see how it would fare in the US, where the requirement for a clearing agent and the need to post margin are seen as the OCC’s main obstacles to greater success.
Here is Eurex’s announcement about the upcoming launch.