In its latest Research Note, ISDA examined recent trends in the clearing business in the United States and the European Union.
The ISDA Research Note found, among other things, that:
- shifts occurring in the business models of futures commission merchants (“FCMs”) due to the impact of new capital requirements and rising operational costs have led to significant changes in the market share of top FCMs in the United States;
- some derivatives users were dislocated from their existing FCMs and needed to establish relationships with new FCMs in order to continue using swaps mandated for clearing;
- FCMs are imposing increased costs on smaller derivatives users (survey results in the United States estimated fees from $60 to $150K over the life of a cleared swap); and
- monthly mandatory minimum clearing fees and minimum revenue thresholds among larger clearing members in the European Union could range from $100,000 to $280,000 per year, and that range of costs is becoming increasingly common in the United States.
In conclusion, ISDA noted, one of the main effects of the increased cost of cleared swaps is this: end users are being pushed to choose alternative hedging measures and/or accept greater risks by either not hedging or using imperfect hedges.
Lofchie Comment: The bottom line of ISDA’s analysis is that, (i) despite all of the outcry about too-big-to-fail, regulatory costs weigh most heavily on smaller institutions, whether buy-side or sell-side, and (ii) increasing the costs of entering into derivatives transactions makes hedging more expensive, which increases risk in the economy generally, even if the risk of derivatives specifically is decreased. To put this in practical terms, if a small firm is prevented from hedging with derivatives in a way that would reduce that firm’s risk, then (a) the risk of derivatives seems to be reduced (since you can’t default on a derivative into which you can enter), but (b) the actual risk to the business (and to the economy generally) is increased because the small firm can’t hedge.