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What are the key reasons that third party clearing models can bring value in Asia Pacific?
What are the key reasons that third party clearing models can bring value in Asia Pacific?
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What are the key reasons that third party clearing models can bring value in Asia Pacific?

18/06/2020


Gary O’Brien

Gary O’Brien

Head of Custody solutions in Asia Pacific

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In 2017, BNP Paribas released a paper that asked if brokerage firms in Asia Pacific had reached a tipping point. In this paper we highlighted a number of factors that looked to forecast a potential change in preference towards third party clearing and away from account operator or self-clearing models.

It is now time to revisit this paper and ask how Asia Pacific’s markets continued to evolve in the last three years? How have ongoing regulatory change, market activity and technical evolution impacted the direction that brokerage firms are taking? Is 2020 the age of third party clearing in Asia Pacific?

During the first three months of 2020, markets in Asia Pacific saw record trading volumes as a result of market volatility (reaching 70% in some markets) triggered by the global pandemic. As a result, broker turnover and revenues increased sharply.

The sudden growth in activity created challenges. On 17th March, the Philippine Stock Exchange closed alongside cash and bond markets. Elsewhere, volatility resulted in the growth in margin requirements for market participants for both equities and derivatives, putting strain on liquidity. Some brokers struggled to manage volumes either on account of manual back office processing or insufficient technical capacity. Indeed, concerns in some markets led to greater scrutiny from market exchanges of the trading activity of their participants as well as increased focus on their technical capacity.

With the potential for continued periods of market volatility and high volume activity, brokers in Asia Pacific are accelerating restructuring and reexamining target operating models to ensure they have the solutions in place to best manage any potential market stress.

Keeping pace with capital market changes in Asia Pacific

All these challenges come at a time when many Asia Pacific markets are transforming their clearing and settlement practices, through regulatory changes, new products and technological innovation.

For instance, the Australian Stock Exchange (ASX) is powering ahead with the implementation of a Distributed Ledger Technology (DLT) replacement of its CHESS infrastructure. This is scheduled to go live in 2021. Also for 2021, Hong Kong Exchanges and Clearing Limited (HKEX) is continuing to develop its DLT solution for post trade and pre-settlement in respect of Stock Connect, whilst reviewing a potential restructure of its clearing house structure. Singapore Exchange Ltd (SGX) is refining its new settlement system (SGX-PTS WEB). And India is implementing an interoperability solution in its own clearing house model.

Furthermore, at a time of increased market volatility and evolving market structures, local regulators are reviewing existing market frameworks to ensure they are fit for purpose in terms of risk mitigation and investor safety. All in all, in such a dynamic environment, the burden on a self-clearing broker to invest and adapt to these new infrastructure changes could easily become substantial and a significant distraction.

Of the various options available to brokers, third-party clearing (TPC) offers clear benefits. While self-clearing may sometimes be seen as cost-effective for those managing large trading volumes, TPC can reduce capital outlays such as investing in a back-office system and hiring staff to manage the operation. TPC also makes for a better choice in many markets over the legacy account-operator model as it can help reduce costs and the broker’s expenses associated with direct regulatory compliance responsibility.

Consider also that securities service providers are typically at the forefront of anticipating new regulations and the impact on their clients. Brokers can count on TPC clearing to reduce their compliance burden and help them navigate the constantly shifting maze of regulations across Asia Pacific markets. A TPC model also helps streamline clearing and settlement functions, reducing ongoing project expenditure on operations and IT, freeing up the broker to focus on its core business.

Optimising liquidity across the region

First, there is the perennial issue of liquidity which is a very different proposition in Asia than in Europe and the US.  Different markets in Asia Pacific use different currencies, with different funding available in each. As such, investors selling one security in one market are required to go through an FX transaction to cover a securities trade settling in another market. This can cause a delay in funding. Similarly, brokers that operate regional hubs in Asia Pacific may need to move funds from market to market to effect the timely settlement of transactions with their clients. One solution is for brokers to seek intraday liquidity solutions from their banking partners, in order to cover any peak activity whilst avoiding significant fixed costs that could hit profitability.

An alternative financial solution can be provided through TPC: the clearing party could, for instance, provide intraday liquidity solutions to the broker on an uncommitted, undisclosed basis to assist in the coverage of their daily activity. Or they could do so on a committed or overnight basis to add more certainty (at an additional cost).

Third party clearing can deliver significant cost savings. Costs such as capital requirements, payments of margin calls and contributions to the default fund are passed to a TPC partner. Added to which, TPC does away with the need to maintain a separate relationship with a local bank for cash settlements and liquidity requirements. In the account operator model, the broker is responsible for all of the above except infrastructure upgrades.

Access to future DLT infrastructures 

A third party clearer can also provide clients with access to technological expertise, which is particularly useful in managing changes to market infrastructure. Adapting to the digitisation of post-trade systems -either through new technology like blockchain or the introduction of new messaging standards - can be a challenge.

As an example, BNP Paribas owns a stake in Digital Asset, a fintech company that has worked on both the ASX and HKEX projects. In parallel, BNP Paribas Securities Services and Digital Asset are designing a number of solutions that will provide market participants with ready access to this new generation of DLT-based trading and settlement platforms, such as a Corporate Action Deadline Enhancement app, which will significantly speed up the processing of corporate actions.

Even large international brokers with established self-clearing infrastructures in their home markets would be better served by outsourcing to an established third party clearing partner in Asia Pacific. Compared to self-clearing’s high fixed costs such as capital for collateral, staffing and compliance; outsourcing the service can lead to lower and more manageable variable costs and means that the international broker no longer needs to keep a very close eye on the ongoing changes in each local market.

International and local expertise in clearing

In essence, a third party clearing partner combines a broad range of financial services: custodian, settlement agent, netting provider, liquidity provider, and settlement and cash bank, not to mention a technology provider with guaranteed operational support.

A regional expert such as BNP Paribas Securities Services, one of the largest third-party clearers in the region, can bring a consultative approach and dedicated teams of local experts. As the region moves to implement wide-ranging changes to its market infrastructure, many of which are expected to be along the lines of those in practice in European markets, BNP Paribas Securities Services is well positioned to assist investors to make the most of the opportunities offered by the Asia Pacific markets.

Table of third party clearing benefits

  • Potential to reduce capital burden on the executing broker
  • Coverage of market enhancement costs by the clearing agent
  • Reduced impact of peak activity (technology, capital, operational)
  • Move from a fixed cost to a variable cost structure for operation and technology
  • Outsource post trade regulatory burden
  • Centralise post trade banking, operating and technical relationship with one provider
  • Benefit from best in class expertise of specialized providers
  • Make use of clearing agent’s innovation in areas of importance, whilst being shielded from ineffective change

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