How can banks and brokers mitigate the cost and complexity stemming from non-stop regulatory and market infrastructure changes, new capital rules and thinning margins? The answer for a growing number of institutions is to turn to third-party clearing.
Across geographies, the cash equity self-clearing model is becoming increasingly complex and expensive.
Direct membership of clearing venues comes at a substantial cost, making it uneconomic for firms that lack significant volumes and scale. In Europe, where the market is highly fragmented, members will need to connect to multiple clearing houses, with each bringing its own connectivity and operating specificities.
Regulatory initiatives (such as the European Union’s Central Securities Depositories Regulation and its emphasis on settlement discipline),market infrastructure changes and consolidation add further complications.
In Europe, Euronext recently acquired the Borsa Italiana Group, while Swiss markets infrastructure operator SIX Group completed its purchase of Spain’s Bolsas y Mercados Españoles last year. At a more day-to-day level, operators often roll out minor updates to their reporting formats and platform technology. In each case, direct clearing members will need to invest time and resources to understand and adapt to the changes.
Similar issues can be found across Asia Pacific, where a combination of new regulations, products and technological innovations are transforming markets’ clearing and settlement practices.
The Australian Stock Exchange’s project to replace its CHESS infrastructure with a distributed ledger technology-based platform is a prime example. Hong Kong Exchanges and Clearing is also introducing a Distributed Ledger Technology (DLT) solution for post-trade and pre-settlement through Stock Connect, while Singapore Exchange is refining its new settlement system. Understanding what infrastructure and regulatory changes are taking place, and the implications of those for connectivity and market operations, requires on-the-ground expertise – something international brokers may not always have. Optimising liquidity across the APAC region poses a further challenge. Collateral consumption and balance sheet management are a top priority for brokers. But unlike the United States and much of Europe, markets in Asia Pacific use different currencies, each of which requires liquidity and clearing. Investors selling a security in one country must complete an FX transaction to cover a securities trade settling in another, potentially causing funding delays. Brokers may also need to move funds between markets to complete timely transaction settlements with their clients.
Benefits of third-party clearing
Third-party clearing enables brokers to team with an expert, on-the-ground partner to help navigate market complexities and evolutions, cut costs and reduce their capital consumption – freeing brokers to concentrate on their core competencies.
Outsourcing transfers the considerable fixed costs of clearing – including establishing and maintaining connectivity to multiple Central Clearing Parties (CCPs), developing and supporting technology solutions, hiring staff to manage the operation, and contributing to default funds – to the third-party provider. Brokers no longer need to maintain separate relationships with local banks for cash settlements and liquidity requirements. High levels of automation, scale and settlement efficiency deliver further operating cost advantages.
Brokers can benefit from more attractive pricing too. The more scale a clearer has at a CCP, the more cost allocation can be reduced, which can in turn benefit clients.
Working with a third-party clearing provider with a considerable buy-side client base also offers an increased level of internalisation in some APAC markets where both the broker and buy-side order are from clients that contract to the same clearer and custodian. Such transactions can be settled across internal books rather than across the market itself, leading to a reduction in market fees.
Complexity and adaptation
As a direct clearing member, the third-party provider assumes responsibility for adapting to all market and CCP changes. Local experts can manage the shifting maze of regulations across markets, along with any changes that are introduced in the clearing space – whether it is large scale M&A market transformations, the launch of new trading venues, or iterative updates to rule books. As a result, international brokers no longer need to stay up-to-speed on the changes taking place in each of the markets in which they operate.
Market advocacy is another element. Offshore brokers in particular lack the local market presence and expertise to interact with regulators and infrastructure providers on market proposals and changes. A general clearing member can ensure its clients have a voice at the table and, through its experience in other markets, offer guidance to CCPs on adopting best practices.
Third-party clearing offers users safety and strength. Operational and counterparty risks are transferred to the provider, while a strong balance sheet and high credit rating make them robust partners. With their scale, focus and budget, third-party clearers can invest in sophisticated technology and resilient operating processes to increase automation. Having experienced subject matter experts to manage daily clearing activity and navigate market changes reduces risks further.
Third-party clearers can also optimise margin calls and collateral management. Margin calls are sent by the CCP to the general clearing member, so at BNP Paribas Securities Services we centralise and harmonise the margin call process across all venues. Clients can cover any risk increases with the collateral of their choice (i.e. cash or securities). We then optimise the collateral posted to CCPs on a daily basis. Consolidated reporting indicates each CCP margin requirement and is sent daily.
The risk of settlement failures or potential buy-ins is also reduced when clients on both sides of the trade contract use the same clearing custodian, since the operational team sees both sides of the transaction internally.
Many financial intermediaries now charge their capital and liquidity costs direct to the individual business lines, heightening scrutiny on how to make best use of their financial resources. Meanwhile, market volatility – as seen during the pandemic – increases margin requirements and puts a strain on liquidity.
Third-party clearing reduces brokers’ counterparty risk and associated capital costs. Brokers that can tap into intraday liquidity solutions from their banking partners can also ensure they have the liquidity to cover peaks in activity.
At BNP Paribas, we monitor clients’ intraday positions and risk, and provide single netting per CCP with a centralised margin call process across CCPs. Clients can cover changes in risk with their collateral of choice, while our liquidity optimisation tool enables brokers to finance their daily margin calls in the most efficient way possible and according to their individual needs.
The BNP Paribas Securities Services difference
Clearing is a core part of the BNP Paribas Securities Services offering, one we are committed to long term. BNP Paribas Securities Services is the number one custodian in Europe, and the number five worldwide . Our clearing capabilities span cash equities, fixed income and listed derivatives, with a 90% global market coverage. Along with a market-leading proposition in Europe, we are one of the largest third-party clearers in the APAC region  and are expanding our presence in Latin America.
Thanks to BNP Paribas’ diversified universal bank model and strong balance sheet, we are one of the best-rated banks in the world. We also have the tools and flexible financing solutions to support clients’ margin funding requirements. That translates into a safe, reliable partner that is well-equipped to manage clients’ risks.
 *By assets under custody
 Largest clearer in Hong Kong and Australia in terms of volume, largest clearer in Hong Kong and Singapore in terms of client base