The future of the clearing industry was discussed at the FIA Forum Sydney at ASX on June 7. Moderator Yeo Tze Min, FIA’s Head of Legal & Policy APAC, introduced the second of the afternoon’s panel sessions. Participants included Nathan Bourne, Senior Executive Leader, Market Infrastructure, Australian Securities and Investments Commission (ASIC); Dale Rayner, legal counsel to FIA and Partner, King & Wood Mallesons; David Stinson, Executive Director, Prime Financial Services, J.P. Morgan; Candice Trevenna, Head of Derivatives Clearing Services, ASX; and Paul Wylie, Head of Risk, Asia-Pacific, LCH Ltd.
Perceptions of Australia’s clearing industry as the gold standard reflect its traditionally safe, efficient management, and strong ASIC licensing and supervision. Systems held firm during the greatest period of stress since 2008, a time covering the COVID-19 pandemic, war in Ukraine and this year’s mini-US banking crisis. Stinson noted that market stability was challenged on busy days as prices fluctuated, clearing volumes jumped and liquidity fell. Clearinghouses with effective volatility controls for products that are susceptible to squeezes and speculation performed better than those that did not. “Volatility controls have never been more important to cool down the market,” Stinson said.
Recalibrating margin models
Though the industry proved capable of handling defaults by the likes of Silicon Valley Bank, the procyclical nature of margins has potential to drive further instability. As Trevenna noted, clearinghouses need to continue “building out their toolkit”. This will involve updating margin methodologies to prepare for any eventuality, potentially using simulation tools and providing greater client transparency. “A cycle of higher defaults will provide a challenge to the whole market,” Wylie said. He explained how LCH has used “volatility floors” to smooth out margin movements. Correlation risks across clearinghouses should also be considered if another global entity defaults. Although the regulators are concerned with fair and effective clearing services, and overall financial stability, Bourne emphasised the regulatory expectation for clearinghouses to manage risk. “We’ve set the standards; now it’s up to the clearinghouse, depending on the products they have and the environment they’re in at any time, to set those risk parameters correctly,” he said.
Navigating the cyber threat
A major theme of the session was improving cyber resilience of clearing services. The panel identified third-party vendors as an important area of consideration, particularly in light of this year’s Ion outage. From a legal perspective, Rayner noted “there are questions around risk allocation and where the loss falls”. To ameliorate third-party risk, panellists urged clearinghouses to identify critical service providers and draw up plans to handle a cyber-breach. “You’ve got a party that’s delivering services to you, but they’re getting services from somebody else. This chain might go on for quite some time,” Bourne said.
ASIC is working closely with industry to share resources, as well as providing information to boards on how to improve their cyber resilience. Its upcoming Cyber Pulse Survey will enable thousands of Australian firms to report and test their cyber readiness. Stronger coordination between government bodies and regulators is also needed to model and communicate best practices. Trevenna noted that cyber resilience should be discussed as a priority with suppliers. “Communicating that uplift in expectations can be a challenging conversation, but it’s one they’ll start to see from all sorts of customers across the globe,” she said.
Future challenges and opportunities
AI and quantum computing offer clearing services the potential to achieve greater efficiencies. “As computing power grows, that gives us the opportunity to change how we do our risk modelling,” Trevenna said. All panellists agreed new capabilities should be introduced responsibly. “Everything with technology is ‘wait and see’. You want to make sure something is proven before adopting it,” Wylie said. Clearing risks for rapidly evolving markets also need to be better understood, especially in relation to carbon and ESG, foreign exchange transactions, and LIBOR replacement contracts. As panellists agreed, not every product has to be cleared, or should be.
Important work is also underway around contract standardisation. Rayner noted this could eventually support greater digitalisation and reduce friction in collateral exchange. FIA’s collaboration with the Derivatives Market Institute for Standards (DMIST) was seen as critical to provide legal clarity about how trades occur. “It’s not just about technology but agreeing how quickly a trade should be executed once it’s given up,” Stinson explained. “Standards around the acceptable window for trades to be given up; for allocations to be sent; for clearing brokers to process that trade. And a dashboard we could use to give transparency around where the trade is. These are the tools that will stand us in good stead next time there’s a crisis.”