Tuesday, September 28, 2010

TABB Says Launch of CFD Clearing Service to Thrive Under New EU Derivatives Regulation; Buy-Side Firms to Benefit

In new research published today, TABB Group explains how a new Contracts-for-Difference (CFD) clearing service set to launch before the end of 2010 by LCH.Clearnet and Chi-X Europe is well timed as European regulators look to move derivatives into a centralized clearing model.

A centrally cleared Contract-For-Difference (ccCFD) is a CFD/equity swap that is initiated as an over-the-counter (OTC) trade and is brought on-exchange and cleared through a central clearing counterparty (CCP) instead of as a bilateral agreement. Clearinghouses and execution facilities are entering the space to benefit from expected growth in CFDs, proposed regulatory changes, and address buy-side concerns surrounding OTC counterparty risk.

According to Will Rhode, a research analyst in TABB’s London office and author of “Centrally Cleared CFDs: A Buy-Side Perspective,” centrally-cleared CFDs (ccCFDs) will add to the size of the overall CFD market, which TABB forecasts at a compound annual growth rate (CAGR) of 23% with notional amounts reaching £1.1 trillion by 2012, with ccCFDs estimated at £110 billion of the overall market.

The new joint initiative, Rhode explains, aims to benefit from expected growth in CFD, the proposed regulatory changes (on September 15, the European Union’s “European Regulation on OTC Derivatives, Central Counterparties and Trade Repositories” ruling proposed mandatory CCP clearing for eligible OTC derivatives) and address buy-side concerns surrounding over the counter (OTC) counterparty risk.

Describing the new service, Rhode points out that while it will not have a formal exchange listing, it will offer a wholesale, standardized CFD product in a central clearing counterparty model with a complete post-trade transparency. Set for a soft launch in the fourth quarter this year at a time when first adopters and allocated clearing members (ACMs) test the waters, he says, the new ccCFD service, which is not expected to ramp up until early in 2011,has the approval of HM Revenue & Customs (HMRC), effectively legitimising tax uncertainty around CFDs.

“The new ccCFD service,” he says, “will appeal to long-only asset managers on the prowl for risk management tools (and currently use single-stock futures), UCITS III funds seeking counterparty credit risk mitigation models, statistical arbitrage hedge funds looking for tax certainty and retail aggregators facing capital adequacy regulation.” In the event that European regulators force CFDs into a central counterparty (CCP) clearing house, he adds, TABB, expecting ccCFDs will ultimately replace the existing OTC CFD market, estimates that the ccCFD market place will grow dramatically, reaching £245 billion in 2011, rising to £440 billion in 2012.

“At TABB,” says Rhode, “we expect that the success of the service will be influenced heavily by the extent of impending regulation. We will see either OTC CFDs forced into a clearing model or, at the very least, make it more capital intensive, in effect more expensive, to provide OTC CFDs.”

The 19-page report with 15 exhibits, based on conversations with long only asset managers, hedge funds, retail aggregators, prime brokers, clearing houses and exchanges, provides a detailed description of the types of firms that may be attracted to a clearing service for CFDs, and their respective motivations for doing so. It also examines key regulatory developments and their potential implications for the new service’s launch.

The report is available for immediate download by all TABB Research Alliance Equity clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. For an executive summary or to purchase the report, please visit http://www.tabbgroup.com, or write to info@tabbgroup.com.

No comments: