* Will not tolerate "race to the bottom"
* Says cheap clearing is false economy
* Sees no sign of collateral crunch
By Huw Jones
LONDON, April 24 Britain's new regulator for
market operators warned clearers of tougher policing of fees to
stamp out cut-throat competition that risks undermining
World leaders agreed during the financial crisis to reshape
the opaque $640 trillion off-exchange derivatives market for
interest rate, credit default and other swaps by requiring many
of the contracts traded between banks to be cleared by a third
party that has a default fund to cover losses.
Clearing stands between two sides of a trade to cut risks by
monitoring the transactions and making sure the default fund is
The new derivatives rules are part of a wider set of reforms
to make markets safer, including higher capital requirements on
Investors were left guessing who was exposed to uncleared
derivatives at Lehman Brothers when the bank collapsed in 2008,
with the uncertainty sending markets into near meltdown.
The prospect of vast amounts of new clearing business has
prompted exchanges to acquire or set up clearing houses in the
hope of generating fresh cash streams to offset depressed
"We are not in the business of preventing competition but
what's important is the terms of that competition," Britain's
new clearing supervisor, Edwin Schooling Latter, told Reuters in
The Bank of England became the regulator for clearing houses
this month and Schooling Latter said in his first media
interview he will not tolerate "a race to the bottom" such as
clearers allowing banks to post too low margins against trades.
Margins refer to traders of derivatives posting government
bonds or other high quality collateral to help cover any losses
and the level of margins is determined by the clearing house.
"We want a world where the clearing houses compete on the
quality of their risk management and not on how low their
margins are," Schooling Latter said.
He also supervises settlement houses that exchange legal
ownership of securities for cash, and the UK payments systems,
with all three components key to financial stability.
He said clearers stayed resilient in the financial crisis
but he wants to make sure they have enough capital to avoid
needing taxpayer help in any future crisis.
He said he is checking if default funds can withstand the
two biggest customers collapsing and whether clearers are asking
for enough initial margin from users to back trades.
The final and new line of defence is for clearers to have a
recovery plan on how losses would be allocated.
"This is a big change. The recovery plan is not a complete
task but I don't want to be moving into 2014 with lots of
uncertainty over how those recovery and loss allocation plans
would work." Schooling Latter said.
He supervises four clearers based in Britain serving the EU.
Chicago-based derivatives exchange CME and its
Atlanta rival ICE have set up clearing operations in
London to compete with LCH.Clearnet, in which the London Stock
Exchange is taking a controlling stake.
Andrew Lamb, CEO of CME Clearing Europe said the primary
focus of any clearing house should be on the quality of risk
management to meet the needs of customers. ICE and LCH.Clearnet
had no immediate comment.
The central bank will also supervise EuroCCP, which clears
share trades, and a planned clearer at the London Metal
Schooling Latter warned banks about pressuring clearers for
lower margin requirements.
"They need to be wise. There is no free lunch in central
clearing. If you've got low margin requirements then probably
other participants do and you've got to think about what that
means for the risks that you are bearing," he said.
Greater risks means that the banks would more likely bear
losses under the new recovery plans, he said.
Banks say tougher margin requirements will create a
collateral crunch and make lending to the economy harder.
"I don't think we are in a place where it's case proven that
there isn't enough collateral," Schooling Latter said.