By Michael Gort, Head Clearing Products, SIX

One would be hard pressed to find market participants against the principle of greater interoperability between clearing houses (CCPs). Despite some challenges in the initial phase of pan-European CCP interoperability, the model's immense success persists, benefiting participants in the European cash equity markets to this day.

MiFID unquestionably laid the groundwork for interoperability, enabling trading of the same instrument across multiple trade venues. The consequent increase in competition in share trading fostered price reductions, growth and innovation also in the clearing space.

Interoperability increases efficiency

As market participants embraced the newly established multi-lateral trading facilities (MTFs) in the early 2010s, they encountered a challenge; settling the same instrument multiple times and providing collateral to each connected CCP, highlighted the need for a more streamlined approach. Trade venues, particularly MTFs, began offering access to multiple CCPs. This allowed trading participants to consolidate trades in the same instrument executed on various platforms and direct them to a single CCP. The multi-venue CCP would then combine the participants' transactions from all platforms into a single net settlement per instrument, leading to a unified margin requirement for the netted position. For this model to effectively work, CCPs clearing on the same platform established interoperability agreements, enabling them to manage their respective bilateral exposures through a mutual linkage.

Embracing the power of choice: a decade of growth for interoperability

BATS Europe, a prominent MTF during that period, addressed this problem by introducing the innovative "preferred interoperable clearing" model. This model, launched in 2011, initially involved three interoperable CCPs in addition to the incumbent CCP that was not obligated to interoperate. The trade execution would be cleared by the designated CCP(s) only if both counterparties selected one of the interoperable CCPs as their preferred choice. Alternatively, if no interoperable CCP was chosen, the trade would, by default, be cleared by the incumbent CCP.

The gradual adoption of interoperability marked a significant milestone in fostering a competitive European clearing landscape that promotes efficiency and innovation. Soon after interoperability was introduced on the MTFs, it quickly became evident that market participants were willing to shift their business when presented with options of CCPs. This development has had a profound impact on the post-trade industry, delivering substantial benefits through enhanced competition in clearing. Notably, reduced CCP memberships, a decrease in the number of settlements per instrument thanks to netting capabilities across multiple trading venues, lower margin requirements and consequently, less collateral and liquidity tied up with CCPs. These factors have contributed to the resounding success of interoperability. The increased competition among CCPs has been accompanied by an unparalleled decline in transaction fees per transaction, which have steadily decreased as a result of intensified competition among CCPs.

A slowdown in interoperability growth

Despite the evident advantages of interoperability, the last few years have witnessed a slowdown in adoption of the model across Europe. This stagnation can be attributed less to a waning market interest, as the demand for interoperability from market participants is unchanged and more to an unwillingness of trading venues and exchange groups opening up. But attitudes may be shifting, as exchanges are recognising that an enhanced post-trade model could boost their attractiveness vis-à-vis the growing MTFs with which they compete for market share.

Is preferred clearing the solution?

While the concept of "Preferred Clearing" in pursuit for additional growth and competition, may seem like a solution at first glance, it is important to approach it with a critical perspective. Although this model offers a slightly more integrated and efficient alternative compared to the traditional silo model (with one CCP per trade venue), it still obliges members to connect to and hold a Membership with the incumbent CCP as well as their preferred CCP. For market participants actively engaged in various trade venues across Europe, who want to optimise the number of CCP relationships, interoperability remains the preferred choice.

Even so, exchanges that are as yet unwilling to embrace interoperability but wish to offer some amount of competition continue to propagate the preferred model. Preferred interoperable clearing may be the next step in the evolution of cash equity clearing. Introducing multiple singular "preferred" CCPs alongside one incumbent CCP, offers market participants an expanded range of choices. However, this model might also give rise to increased fragmentation across the broader market. To address this issue, the earlier concept put forth by BATS Europe in 2011 may be worth revisiting: preferred interoperable clearing.

Preferred interoperable clearing has the potential to address multiple challenges simultaneously. Firstly, smaller local participants, who primarily trade on the primary market and have limited interest in trading the same instruments across various European trade venues, can continue to use the incumbent CCP, which they are accustomed to, rather than engaging in interoperable transactions that may result in higher margin requirements.

Fragmentation is significantly reduced, when compared to the singular "preferred" model, as the chances of encountering counterparties who also opt for interoperability are higher. This alignment of preferences enhances the potential for consolidating trade flow with the main interoperable CCP. As a result, participants embracing the preferred interoperable clearing model can achieve notable efficiency benefits.

Increased competition is fostered among participants, providing them with a real choice between CCPs and clearing models. Participants will be able to select the model and the CCP that best supports their operating models: an interoperable model with an increased margin but higher netting potential or remaining in a silo model with the incumbent CCP with lower margin requirements and lower netting potential.

Given the current market environment, it seems unlikely that many additional markets will embrace pure interoperability, despite the demand from market participants. However, if deployed, an interoperability strategy can allow market participants the ability to pursue opportunities for consolidation and netting, thereby enhancing efficiency and offering greater benefits to their members. Striving for increased efficiency across the market while considering the diverse profiles and requirements of clients makes the preferred interoperable clearing model a promising avenue to work towards.