Josh Braverman, Senior Executive Director,
Treasurer, Head of Derivatives, AXA US
Risk: Capital charges such as the supplementary leverage ratio (SLR) are challenging the economics of clearing - how do you expect the clearing landscape to change between now and the introduction of the SLR in 2018?
Josh Braverman: The SLR divides Tier 1 capital by a measure of total assets, including outstanding derivatives cleared for clients, but without any offset from the IM posted by the client. This means that providing clearing services will become a more expensive and capital-intensive business than it is already. There may be fewer FCMs as firms optimize their capital allocation, and that these firms, some of whom are already increasing fees due to existing cost pressures, will pass along their increased costs in the form of higher fees to clients. On the other hand there is a lot of growth to be had in clearing as it expands to new instruments and geographies.
Risk: How has the clearing mandate affected the back-office operations and processing of OTC derivatives? What processes need reviewing?
Josh Braverman: There were several major operational impacts of clearing and Dodd-Frank/EMIR, including the need to upgrade collateral management to support same-day settlement, establishing connectivity to the SEFs, enabling portfolio compression and netting, and supporting portfolio reconciliation. This entailed both a significant start-up cost and higher ongoing costs, although the upgrades have yielded benefits beyond regulatory compliance, in terms of automation, efficiency and capacity. For example our new order management system removes a lot of the manual re-entry steps as the trade information goes from portfolio manager to trader to back office. One process that would benefit from further refinement and standardization is netting and compression for cleared swaps.
Risk: Clearing members have been complaining about a lack of CCP "skin in the game" high up in clearing house default waterfall - what are CCPs doing to address these complaints?
Josh Braverman: The amount of the CCP's own capital that is put up to support losses in the case of a member default is generally small compared to the amount contributed by the clearing members, and therefore unlikely to make a difference in the case of a major member default. Some CCPs have defended the current level of capitalization and while others have made plans to recapitalize, this is likely to be funded by the members, and in turn by their clients via fees.
Risk: What concerns are you hearing from your clients and industry peers? Concerns about mounting clearing costs due to the SLR and other capital charges?
Josh Braverman: Apart from concerns about the increased costs associated with SLR, our main concerns are more about uncleared derivatives, with the high margin requirements being phased in over the next several years. If nothing changes, these will increase our cost of managing market risk. We've been a limited user of cleared OTC derivatives to date, because our current risk mitigation needs are best met by futures and by OTC instruments not yet available for clearing. We are concerned about whether the cleared markets can fill the void and provide the risk mitigation tools we need by the time higher requirements for uncleared OTC take effect. If not, a further increase in futures usage may be an appealing alternative in order to reduce frictional costs, although it would entail a loss of customization to our risk profile.
Risk: With SEF rules under scrutiny, what changes you expect to see in swap trading rules? Can the Bloomberg-Tradeweb domination in D-to-C Sef trading be challenged? If so, by who?
Josh Braverman: There is a push to support the transformation of cleared swap trading into something more closely resembling futures trading, such as the move to anonymous bidding in the limit order book setting. However it remains to be seen whether the swap market will adopt the degree of standardization inherent in that model. Regarding Tradeweb and Bloomberg, much of the value of using a particular SEF is in having access to a wide range of potential execution counterparties. This is an advantage for the incumbent SEFs, and it will be hard for a smaller player to challenge them on the basis of greater functionality or lower price, particularly given the cost involved in either of those approaches.
Risk: Like-for-like comparisons between the risk management processes in place between CCPs are very difficult to obtain. What can be done to increase transparency and comparability between CCP default fund contributions and risk parameters?
Josh Braverman: As we are in a sense counterparties to the CCP, and given the potential size of the exposure, we think it would be useful to have greater insight into the stability of the CCP's. However the level of capitalization is still one consideration among several in choosing a clearinghouse, including pricing, liquidity, margin requirements, and the suitability of substitute instruments that are available outside the clearinghouse.
Risk: In your opinion, have regulators achieved what they wanted in the 2009 G20 commitments? What would be on your wish list for regulators?
Josh Braverman: Good regulatory progress has been made toward greater financial stability in both the US and Europe. Even some regulators, however, seem to agree that there is work to be done in order to achieve fully functional cleared swap markets, although the cleared swap market is in any case still not at a mature state. Our regulatory wish would be harmonization between derivative regulation and capital requirements for systemically large financial institutions. As a large global insurer, we've seen derivative positions play a role in our designation as a GSII, which we see as based on a misconception of how derivatives are used in our industry: insurers like AXA are primarily using derivatives to manage and reduce risk, not to take on risk. Clearing and margin standards under Dodd-Frank and EMIR already address interconnectedness risks, so we feel that further added GSII capital requirements for derivatives would be redundant and unlikely to improve market stability.