Tuesday, November 25, 2008

One year after MiFID, where is liquidity going?

This morning I read the following:

Chris Skinner posted the following comment on one of his blogs based on a panel he moderated at trade tech liquidity:
"I .... ask(ed) a dumb question, “as EMCF only has two risk managers and is now run by the Dutch Government, isn’t that bad for business?”.

Well, I'm going to take the bait:

(Please note: Since the equinox study EMCF reduced their fees to 5 euro cents - the Equinox study gives some context as to where we came from in 2006.)


Chi-X is a price discovery platform for blue chip and second line equities. EMCF likewise is a CCP focused purely on a single asset class over a T+3 settlement period (T+2 for Germany).

Let's consider a parallel with another industry. Many of us use public transport to get to work – are we suggesting that each and every rail commuter have a guard with them for health and safety? What is the ratio of staff at banks per transaction processed? We are talking in a technological age where we use technology to perform ‘peak transaction’ processing.

Risk management is a sub second world is not about people watching trades. It is about systems, procedures, rules etc. To date the regulators have proven very effective at supervising all the new CCPs. I recommend any of the national regulatory reports (FSA, DNB etc.) where you can see first hand how CCPs are measured against the CPSS / IOSCO standards. Let the regulators continue with their jobs.

A CCP operates as a closed eco-system. There are layers of protection from participation criteria, margining (remember the focus here) and elements of mutualisation such as a default fund. In between there may be other layers of protection of various degrees. What is important, and what the regulators accesses, is the ability of a CCP to handle default events without recourse to external capital. Neither the capitalisation of the CCP nor its ownership could be relevant in the event of adequate margins being called. When a CCP is stress tested, it is done on this basis. If the overall protection is not sufficient you will see either an increase in margin rates, default fund requirements or other. Again, leave the regulators to carry on doing their supervisory role.

Personally, like many of us, I don’t think there was any joy in allowing Lehmans to fail. Nor for that matter in any of this market turmoil. That said, EMCF has experienced a default event and within 36 hours all EMCF participants were assured that there would be no recourse to their default fund contributions. This was possible in part due to the focus of the assets serviced and risks monitored. Again, the ownership of EMCF had no bearing on this event. This was simply a CCP doing what it is created for.

To date we have seen no failure by the regulators in their supervision of CCPs. That is not to say they should not be challenged but let’s do it constructively.

As evidenced by the industry, there is a demand for competition. Lets support that. Fragmentation is the cost that allows the benefits of competition to accrue to the market. Embrace the evolving market place and do your bit for all Europeans!

People also want cheaper post trade costs. Remember clearing (risk management and charged per transaction) is different from settlement (change of ownership and charged net per transaction). EMCF has hammered down clearing costs to 5 eurocents and the primary market CCPs have begun to respond. EMCF has identified there is a place for new entrant CCPs and indeed they have come (e.g. EuroCCP).

If anyone wants some slides on how EMCF has driven down fees I’ll post these on my blog:

Finally, please note, these views are my own. I make these as an individual that believes in a better deal for European Capital markets.

I’m sorry to have taken the bait on this one, but I think it would be irresponsible not to.

Scott Riley

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