The third installment of the three part series, here Erik Mueller, the chief executive of Eurex Clearing, discusses how clearing efficiencies are changing the trading landscape

European policymakers have made in recent years no secret of the fact they are unhappy that Euro swaps are mostly cleared at LCH in London and Euribor futures are mostly traded and cleared at ICE also in London, outside of European regulatory control since Brexit.

Frankfurt-based Mueller continued: “It wasn’t a priority a year ago but it has become more urgent for market participants to be able to look at this from a more holistic perspective around the Euro risk.”

While LCH generates margin savings by clearing swaps of different currencies, Eurex is taking a different approach, aiming to clear as many Euro products as possible under one roof.

“The competing value proposition is to look at a single product across multiple currencies which offers benefits to some but not all. The European buy-side for example is mostly focused on the Euro but for the dealers the multi-currency proposition is attractive.”

Mueller continued: “We think the future is in delivering efficiencies across these different products within a single liquidation group. One thing that is under-estimated is that repo is the grease in the financial system and not only as a source of liquidity for banks but also as a backstop for those buy-side firms that have become part of the risk management processes of CCPs by putting up initial margin (IM) for future market moves and variation margin (VM) in cash to settle the daily mark-to-market.”

Eurex, like LCH, has reported a spike in demand for cleared repo as firms such as buy-side clients have reacted to bank liquidity concerns in the first quarter by using more cleared products to mitigate counterparty risk.

“Of course, the non-banks don’t have the same access to liquidity that the banks have so they are reliant on well-functioning repo markets and they are discovering that because of the balance sheet cost of the banking regulation, there are gaps at month and year ends where banks are seeking to optimise their G-SIP scores. It can become prohibitively expensive for them to extend financing to non-bank clients.”

Mueller added: “Against that background, we are observing a strong movement into the cleared repo space. Europe, unlike the US, is not yet considering a clearing obligation but the recent FSB report on leverage in the non-bank financial system suggests the answer is in a portfolio margined universe of STIRs, long-term interest rates, IRS and repo, and there is a strong point to be made that this would be the natural home of the Euro currency.”

“That is what we are working on and STIRs fit in as one piece of the puzzle that delivers greater efficiencies to market participants if you feel that capital efficiency is the big driver going forwards,” he added.

And Eurex sees parallels between what it is trying to do with Euribor and its success 25 years ago with the Bund.

Mueller said: “In a way, they are comparable in that you had two major prerequisites. With the Bund, there was a regulatory break with the Investment Services Directive so there was no need to physically present in a pit anymore and then there was the technology.”

He continued: “If you look at this situation, it is both again. The regulatory rules are changing. The ECB has said consistently and prior to Brexit that there is a need to be responsible for systemically relevant exposures in the Euro currency.”

Mueller said the European Central Bank signalled as early as 2011 its intention to repatriate Euro-denominated products into the Eurozone.

“With Brexit now a reality, it has become more urgent for European regulators to want a certain proportion of the EU systemic risk to be housed within the perimeter of their direct supervisory powers. I think that is an important change.

He added: “There are many points of evidence that the passport that was crucial to allow London to manage the finances of EU has effectively fallen away. That cannot be the status quo going forward so the question is how can we help transition into a new world?”

And the last component is the technological advantage. “The technology part is not this time a trading system, but it is around risk management. If you look at the four global CCPs, we are the only one that has a full bank licence because we think that access to liquidity matters also for CCPs, not for business as usual but when you go to the end of the waterfall, these banks can become decisive which is why voluntarily we are not only an EMIR (European Market Infrastructure Regulation) registered CCP but also offer full access to the ECB.”

Mueller added: “So there is both a regulatory break and a technology break here that could be the basis for success.”

Looking ahead, there is further to go on the expanded scope of clearing houses as new issues come to light, argues Mueller.

“Look at Archegos, it took a car accident for the industry to realise that maybe we are not as standardised from a risk management perspective as we should be whereas clearing offers exactly that as the banks can’t be played off against each other. If you drill down in futurisation, you come to clearability.”

As well as repo, which is part of Eurex’s broader rates strategy, Mueller said there is also potential for increased adoption of clearing in the still largely over-the-counter foreign exchange market.

“If you look at the capital rules, FX was out of the equation for years but now Uncleared Margin Rules (UMR) and other rules are now shifting what was previously a prime broker business to a cleared proposition,” Mueller concluded.