| | December 20159years. Rather than simply giving up on these relationships, firms must begin to embrace the industry-wide push toward clearing and take advantage of the rising industrialization of this sector.To help offset the upfront and running costs of offering client clearing, banks are moving toward creating a client servicing utility platform for OTC derivatives. Creating a market utility is a challenging but worthwhile effort that requires forming a consensus on a number of levels, from high-level concepts, such as membership commitments and product scope, to the more focused details like vendor selection and client on boarding. This type of cross-market collaboration would have been largely unthinkable in years past, but today, firms across all sizes and geographies are working together to better meet their clients' needs.ConclusionAs rising costs have made it more difficult to retain clients, the market has recognized that it is more important than ever to maintain a full service offering to clients. Client clearing is just one service that has proved to be a necessary expense. Banks have determined that offering client clearing services keeps clients engaged in more profitable lines of business such as bond issuance and structured financing. Firms that do not offer clearing must give up client contacts and data to their competitors and risk losing long-time customers. The high cost of this service offering puts an emphasis on the need for a rational data structure and automated back-office processing. Banks that cannot afford to offer client clearing on their own must find innovative solutions, such as establishing an industry utility, to keep up with their clients' demands.Becoming an FCM involves a significant up-front capital outlay: To self-clear at LCH. Clearnet's SwapClear, clearing brokers pay up to £2.25 million annually, £10 million toward a default fund andanadditional£3million in respect of SwapClear's Tolerance Contribution Amount. Default funds and capital requirement changes for FCM's will force clearing members to charge between 20 basis points (bp) and 45bp on initial margin just to break even on funding and counterparty risk costs.Firms that offer client clearing may need to invest in highly complex collateral optimization systems that analyze how to allocate collateral as efficiently as possible. They also face client requests to report swaps to regulators, since ESMA has mandated that both counterparties of a swap must report trade details to a trade repository. Banks may feel pressured to offer this expensive service without guarantee of enough of a client base to warrant the high costs.Navigating the RisksThe risks of client clearing are present at both sides of a clearing broker's relationship. Clearing brokers assume the risk of their clients and must guarantee and/or immediately sell off their positions in case of a client default. Lack of automation within the sector has forced banks to employ large staffs across various teams such as client on boarding and servicing, compliance and operations. The immediate rewards of maintaining this relationship are few and far between and include small fees that, at best, recoup the cost of the service. As previously mentioned, an FCM's relationship with a clearing house is largely asymmetrical. FCMs must put up capital for membership and must provide connectivity to the clearing house as well as react swiftly to CCP changes in reporting and collateral requirements.Shifting Business ModelsFirms that cannot, or will not, offer client clearing due to the costs and complexity of the infrastructure needed are in an untenable position. Regional banks are the most at risk; they face stiff competition from larger firms with an established capital markets arm and nation-wide commercial banking relationships. These competitors have the ability to offer both structured financial products and clearing. Firms that do not offer client clearing have limited options. Banks may try to creatively structure their clients' swaps so that they do not require clearing, but the final margin requirements for uncleared swaps, as published by the BCBS and IOSCO, will significantly increase margin requirements for these swaps over the coming The client-FCM relationship involves significant credit, capitalization and concentration checks because the FCM must guarantee the client to the clearing house"Adam Kott
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