Active vs inactive clearing brokers

The use of an inactive or back-up clearing broker to protect against an active clearing broker default is generally seen as unrealistic in practice. Clearing brokers will expect to generate revenue for their services and any inactive service arrangement will incur an ongoing cost. It is equally unrealistic to activate a clearing broker relationship from scratch with any speed and certainty.  This limits the confidence that an inactive clearing broker relationship or timely activation of a new clearing broker arrangement could provide support in the tight timeframes required under a default management process.

Ross Gulliford, Head of Investment Operations, Challenger Financial Services Group, comments:

“At Challenger, the use of multiple clearing brokers is important for risk mitigation and commercial flexibility. Should an issue occur with a single clearing broker, we maintain resilient access to market liquidity and put ourselves in the best possible position to achieve portability of our positions and collateral if required – both extremely important in volatile markets. Commercially we take advantage of the flexibility achieved through greater product coverage, wider CCP access and competitive service offerings that we obtain through our multiple clearing relationships.” 

Maximising netting benefits

An obvious objective is to maximise net margin benefits to reduce the funding costs associated with meeting centrally cleared margins. Using multiple clearing brokers can make it difficult to determine how to best maximise the netting of margins. Understanding the firm’s cleared product universe, trading strategy, and optimal account structures will highlight where netting benefits are most significant. For example, the maximum netting benefit may be achieved through a CCP providing access to multi-currency netting benefits within a single product type, or alternatively a CCP providing cross product margining (such as cleared OTC interest rates with cleared exchange traded interest rates), or a combination of both. Clearing brokers also differentiate their offering through the provision of a range of margin netting and collateral services directly to customers if the CCP does not offer a particular service, for certain clients, this may become both an important clearing broker selection criteria; and also a driver for accessing multiple clearing brokers.

Once it is clear how net margin benefits can be optimised, it will be possible to identify how multiple clearing brokers can be accessed without significant impact to those benefits.

Broaden CCP and product access

It’s also important to consider that the development of services and products within the CCP space is always evolving. As outlined in the recent article on improving counterparty access and liquidity through OTC clearing, different asset classes and products shift with varying momentum between trading on a bilateral and cleared basis. Firms should remain aware that the offering across clearing brokers will vary across CCPs, products and regions. Diversification of clearing brokers can help to retain flexibility as the cleared market evolves.

Balancing the benefits and flexibility of multiple clearing brokers with cost

Cost is a consideration that may discourage the use of multiple clearing brokers. Clearing services are charged based on position size and transaction volume. There is often a scale attributed to these costs, or a floor cost to access clearing broker services. If position size and transaction volumes do not meet the floor service cost level, then using additional clearing brokers will increase costs. For these firms a decision to add multiple clearing brokers is generally based around whether the “insurance” cost is worth the risks and benefits it is designed to cover.

Making choices on key service relationships is never an easy process or decision to make. Some may feel that a single clearing broker appointment is their best (or only) option, at least initially. However, with a clear understanding of the benefits and specific needs, firms should be able to build a roadmap to multiple clearers.