News Analysis: EMIR Clearing Delay Prompts BNY Mellon Exit

The European Market Infrastructure Regulation (EMIR) has claimed its latest victim, BNY Mellon’s derivatives clearing business.
By Joe Parsons(2147488729)
The European Market Infrastructure Regulation (EMIR) has claimed its latest victim, BNY Mellon’s derivatives clearing business.

The global custodian announced it has decided to close its European exchange traded and over-the-counter (OTC) derivatives clearing unit as a result of the delay in mandatory central clearing.

“After careful consideration BNY Mellon has decided to exit the European derivatives clearing business. We have taken the view that market and regulatory factors will limit our ability to grow the business in the future,” says a spokesperson for the bank.

“Specifically, EMIR mandatory clearing has been pushed back to late 2015 / early 2016, delaying the expected expansion of the OTC clearing business, which was a key element of our derivatives clearing strategy.

“We are fully committed to providing an orderly wind down process for clients so they can transition their activity to other providers in the market.”

The revelation that BNY Mellon will exit the European clearing business comes one year after it shuttered its U.S. swaps clearing business, citing it had not been profitable and had incurred substantial funding chargers over the last couple of years.

As part of the G20 reforms to OTC derivatives, EMIR sets out certain interest rate and credit default swaps must go through a central counterparty (CCP), or a clearing house, to ensure a trade is completed in the event of a default.

Mandatory clearing was expected to come into force at the beginning of 2015, prompting banks and custodians to prepare their clients’ back offices for the deadline. However the European Securities and Markets Authority (ESMA) announced this summer it would delay the central clearing requirement for buy side firms until January 2016, much to the frustration of clearing members and custodians which have invested millions in ensuring they would be up and running for 2015.

Despite the optimism that clearing banks may benefit from the regulation on central clearing, obviously the opposite has happened.

“They have had to spend a fortune in setting everything up for the January 2015 deadline, but now with the delay to mandatory clearing they would see no revenues coming in until late-2015 at the earliest,” says Tim Reucroft, director research at Thomas Murray, a consultancy firm.

In addition to EMIR, higher capital requirements for global systemically important banks (G-SIBs) in the U.S. are putting added pressures on clearing profits, which also resulting in certain knock-on effects to their European business.

As part of the U.S. implementation of Basel III, large U.S. bank holding companies have become subject to supplementary leverage ratios (SLR), whereby they must maintain a leverage ratio of at least 5%.

“This requires capital to cover the potential future exposure of derivatives (pretty much equivalent to the initial margin for exchange traded derivatives) which is making derivatives clearing even more expensive,” adds Reucroft. “”The problem in the U.S. is that BNY Mellon have had to consolidate all of their accounts around the world because of the rules, and have then taken a big hit because of these supplementary ratio levels. This meant that the European business also took a hit.”

BNY Mellon is the latest major clearing member in Europe to exit the swaps clearing unit, after Royal Bank of Scotland announced last May they would wind down parts of its OTC interest-rates derivatives business due to rising regulatory impacts on profits.

As well as the EMIR clearing timeline, the incoming revised Markets in Financial Instruments Directive (MIFID II) could place even more pressures in the OTC derivatives clearing business, prompting fears that a reduction of clearing members in the market could have significant consequences for clients.

“Existing clients have got some concerns around their existing relationships; they want to know they’ve got consistency and that they have a long-term relationship,” says Jamie Gavin, head of institutional OTC clearing sales, Newedge.

“For clients that still have not on-boarded they need the clearing members to get them ready for the vast changes in documentation, collateral, etc. but with fewer clearing members this is adding to these challenges.”

These exits, along with regulatory costs, could mean volatile price fluctuations for clearing. However according to Gavin, this is a process that is still formulating.

“The pricing within the market is still something that is shaking out. I think clearing members and clients are still feeling their way, and it is still something that is crystallizing in the market.”

Despite the exit from the direct clearing business, there could be opportunities to re-enter the clearing market under the guise of partnerships.

For example, last week Northern Trust teamed up with Dutch-bank ABN Amro Clearing on a solution that combines clearing and custody/collateral management to meet the increased margin requirements.

With this, ABN Amro will assume clearing responsibilities, while Northern Trust will oversee the collateral and moving it into EMIR segregated accounts. The solution will start in the Netherlands but the two firms will then try to grow the offering to other European markets.

A move similar to this could be on the cards for BNY Mellon, according to Reucroft.

“You could see BNYM come out with a similar deal to the Northern Trust/ABN Amro arrangement where they might look for a preferred partner for their clearing,” he adds.

Other partnerships have recently been formed between market infrastructure providers and custodians around clearing and custody/collateral management to fill the gap left by clearing banks and brokers by leveraging eachothers’ capabilities. Last week, for example, the DTCC and Euroclear launched a joint venture for collateral processing.

According to the spokesperson for BNY Mellon: “We are keeping all of our longer-term options open.”