Time running out for buy-side clearing docs negotiation, dealers warn
Dealers have warned that buy-side firms should not leave it until the last minute to start negotiating over-the-counter clearing agreements, because of the risk they may have to adopt standard contracts with no flexibility to make amendments.
The derivatives industry has been working for almost two years to draw up a set of standardised OTC clearing documents to reduce or eliminate the need for negotiation between clearing members and their clients – but the process has not been easy. The Futures Industry Association and International Swaps and Derivatives Association finally released its US version – the Cleared Derivatives Addendum – at the end of August, but the European equivalent has still not been published.
In each case, the addendum will be bolted on to existing documentation – the futures clearing agreement (FCA) in the US and FCA or Isda master agreement in Europe – and is meant to speed up the client on-boarding process and reduce the need for negotiation. Dealers and buy-side firms agree this is vital.
“An industry standard template is imperative considering the amount of work we’re about to undergo. You’re dealing with a $700 trillion derivatives industry with a large number of market users, all of which at a certain point will be required to clear. And the only way we can achieve that is through as much standardisation as possible – there’s not enough time to have bespoke negotiations to meet the mandatory obligation,” says Christopher Perkins, global head of OTC clearing at Citi in New York.
Nonetheless, lawyers for buy-side firms say the standard documentation will not completely eliminate the need for negotiation, and buy-side firms are likely to want to change certain elements in the addendum – in particular, clauses on portability and liability for trades that do not clear.
“There are things we will push back on – the scope of the clearing fails indemnity, for example. Portability we would look to tighten a little bit,” says an in-house lawyer at a large US-based hedge fund.
It’s not just the addendum that will be negotiated, he adds. “A lot of big commercial points outside the scope of the addendum have to be negotiated as well, such as margin terms, position limits and terminations.”
This eagerness to negotiate may create problems for clearing members as the mandatory clearing deadlines under the Dodd-Frank Act approach – particularly if buy-side firms leave it until the last minute, dealers warn. It may get to the point where clients have to accept the standard contract terms with no flexibility for negotiation.
“At some point, that’s got to happen because banks won’t have the capacity in their legal and on-boarding teams to take on a large number of clients at the last minute, all with bespoke agreements. It may get to the point where it would make sense for clients to sign now and negotiate later,” says Dale Braithwait, global head of OTC clearing product development at JP Morgan in London.
“At the moment, we’re negotiating in good faith and we’ve got capacity. But there are so many clients out there that still don’t have clearers – in particular, the smaller players that thought they were going to get an exemption, or would not be covered by US legislation, so put it at the bottom of the list. I’m keen to bring them on board as soon as possible to ensure there isn’t a crunch later on,” he adds.
European clients face a similar issue. Speaking at a conference on September 27, Andrew Ross, European head of OTC clearing at Morgan Stanley in London, warned buy-side firms to start work now, or face disappointment.
“If everyone thinks they can walk through the door at the last minute and find a spot – that’s just not the way it’s going to work,” he said. “If you want to influence the outcome for your firm, then don’t be part of that melee of thousands of people trying to beat the deadline. You need to move now. And if you haven’t moved now, then you’re late in terms of squeezing a better deal, price structure and efficiency out of your clearing provider.”
Lauren Teigland-Hunt, a private practice attorney who represents buy-side firms, accepts some clearing members may refuse to negotiate, especially as the clearing deadline approaches, but says the futures commission merchant (FCM) space is getting increasingly competitive and clients can shop around.
“I think we all recognise that certain clients are in a better negotiating position than others, and it’s going to depend on how much the FCM values its business. But there is more than one FCM out there, and it is a competitive market,” she says.
This article was first published on Risk