The confusion over central clearing

Certainly, exchanges are using the current environment to tout the benefits of the CCP model as a means to eliminate credit risk inherent in over-the-counter trades. Turkey's central bank seems to have deployed a form of CCP to ensure the steady flow of liquidity in the local foreign exchange market by acting as the central counterparty to all trades.

Meanwhile, it is believed major foreign exchange dealers have embarked on an initiative that will use a central counterparty facility for foreign exchange trades, which could be up and running by the middle of next year.

But last Friday (October 17), FXMarketSpace, which used the CME clearing house as a central counterparty, suspended trading as it winds down its operations altogether.

What the three initiatives above help to illustrate is that there is no uniform model for CCP. It seems the term 'central counterparty clearing' means different things to different people. The motivation for employing some form of CCP varies depending on the type of organisation - buy side, sell side, exchange, central bank or regulator.

If the motivation is risk reduction, arguably this is covered by CLS, which on two major occasions in recent years has proved its ability to eliminate Herstatt risk. In 2005, CLS and settlement member JP Morgan were able to settle all trades from Refco, a third-party client of JP Morgan, when the broker collapsed. And last month, the demise of Lehman Brothers hit many markets but, again, CLS ensured the spot FX market continued to operate smoothly.

Another motivation for using a centralised unit could be to reduce the cost per ticket for the industry. This has been an issue for the past few years, with the rise of higher volumes of low-value tickets from algorithmic traders and retail investors.

Either way, there seems to be some form of an evolution taking place, albeit at a very slow pace and disrupted by the current market conditions. That's not to say the existing model will be displaced, just that others will emerge.