Financial Clearing Houses: The Next Casualty Of The Crisis?

Reuters
Jan 16 (Reuters) - Clearing houses -- the plumbers of high finance -- could become the next casualties of the crisis as regulators insist that banks run their riskiest and private trades through them.
At the moment banks conduct over-the-counter trades between themselves: one to one dealings often involving multimillion-euro bets on differences in interest or other rates, the scale and complexity of which can be difficult to track.
But with the financial crisis still raging and banks, hedge funds and governments alike faced with unforeseen levels of debt, regulators are now forcing this shadowy, $600-trillion industry into the light.
The question being asked by industry insiders is whether the clearing houses, also known as central counterparties (CCPs), are any more secure.
"What happens if they go bust? I can tell you the simple answer: mayhem.  As bad as, conceivably worse than, the failure of large and complex banks," Paul Tucker, deputy governor of the Bank of England, said in October.
Clearing houses, such LCH.Clearnet, Deutsche Boerse's Eurex Clearing and the Chicago Mercantile Exchange's CME Clearing, sit between the parties at either end of a trade.
They protect companies from default because they hold collateral on behalf of their numerous members that can be used to reimburse individual firms if one member becomes insolvent -- a standard model used in various exchange-traded markets around the world.
But in taking on over-the-counter (OTC) products the concern is that the clearing houses will not have sufficient collateral to cover the scale of possible future positions.
In the view of International Monetary Fund economist Manhmohan Singh, the central counterparties dealing with over-the-counter derivatives need to hold $2 trillion in collateral if they are to successfully manage this kind of trading.
"The mandated clearing of OTC derivatives is a complex matter on many levels. Derivatives require a lot of collateral because the duration of the contracts can be very long," said Diana Chan, the Chief Executive of clearing house EuroCCP.
Clearing had been a largely overlooked feature of trading on exchanges for decades until it was thrown into the spotlight by the high-profile default of Lehman Brothers in September 2008.
In the aftermath of its collapse Lehman's trading positions in markets that used clearing houses were sorted out in a matter of days. Those in non-cleared markets took months if not years.
Mindful of this experience, regulators in the United States and Europe have urged many of the largest over-the-counter markets to start using clearing houses in order to mitigate against any other default by a large trading firm.
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