The Risk Controllers ─ Central Counterparty Clearing in Globalised Financial Markets

Clearing houses, or CCPs, were among the very few organisations to emerge from the global financial crisis with their standing enhanced. In the chaotic aftermath of the bankruptcy of Lehman Brothers, they successfully completed trades worth trillions of dollars in a multitude of financial instruments across listed and over-the-counter markets, and so helped avert financial Armageddon.

That success transformed the business of clearing. Governments and regulators around the world gave CCPs and the clearing services they provide a front-line role in protecting the global economy from future excesses of finance. CCPs, which mitigate risk in financial markets, responded by greatly expanding their activities, notably in markets for over-the-counter derivatives, and often in fierce competition with one another.

In The Risk Controllers, journalist and author Peter Norman describes how CCPs operate, how they handled the Lehman default, and the challenges they now face. Because central counterparty clearing is a complex business with a long history that continues to influence decisions and structures even in today’s fast changing world, The Risk Controllers explores the development of CCPs and clearing from the earliest times to the present.

It draws on the experiences of the people who helped to shape the business of clearing today. It sets the development of CCPs and clearing in the broader context of changes in society, politics and regulation. The book examines turning points, such as the 1987 stock market crash, that set clearing on a new path and the impact of long running trends, including the exponential growth of computer power and the ebb and flow of globalisation.

Written in non-technical language, The Risk Controllers provides a unique and accessible guide to CCPs and clearing. It is essential reading for clearing professionals, legislators and regulators whose job it is to take this vitally important business into the future.

“The recent crisis has, thankfully, renewed interest in the importance of central counterparties: how they can help preserve stability or, as Hong Kong showed in 1987, undermine stability if they are not super sound. Peter Norman’s book places the role of clearing houses in a historical context, and explains why the financial system’s plumbing matters so much. It should be read by anyone interested in building safer capital markets.”

Paul Tucker, Deputy Governor Financial Stability, Bank of England

Peter Norman is a London-based journalist and writer. The Risk Controllers: Central Counterparty Clearing in Globalised Financial Markets is his second book explaining the workings and history of an important financial infrastructure. Plumbers and Visionaries: Securities Settlement and Europe's Financial Market, his path-breaking account of the history and prospects of the securities settlement industry in Europe, was published by John Wiley & Sons in December 2007.

Peter Norman began a career in journalism in 1968, when he joined Reuters Economic Services in London. He later worked for The Times (of London) and the Wall Street Journal - Europe - before joining the Financial Times in 1988 with responsibility for the newspaper's UK and international economic news coverage. He was the FT's economics editor between 1992 and 1995. Peter Norman spent 22 years of his professional life on the European mainland, based at various times in Frankfurt, Bonn and Brussels. After three years in Bonn as the FT's chief correspondent in Germany, he moved in 1998 to Brussels as bureau chief and chief EU correspondent. He has combined authorship and journalism since returning to the UK in 2002.

Peter Norman was born in 1947, is married, with two adult children. He was educated in England at Hull Grammar School and Worcester College, Oxford, where he studied modern history. He is a member in the UK of the Society of Authors.

Dedication Page
i) Contents
ii) Author's Preface
iii) Thanks and Acknowledgements
Part I - Clearing up the crisis
Chapter 1 Unlikely Heroes
Chapter 2 The modern central counterparty clearing house
2.1 The CCP's unique selling point
2.2 Trading venues and Clearing Members
2.3 Managing Risk
2.4 Clearing derivatives and securities
2.5 CCPs as a business
2.6 Netting Trades and Open Interest
2.7 Vertical and horizontal clearing systems in the US
2.8 Vertical versus Horizontal in Europe
2.9 Risk and responsibility
2.10 Clearing up a crisis
Chapter 3 The Biggest Bankruptcy
3.1 An inauspicious start.
3.2 LCH.Clearnet in the front line
3.3 LBIE - A difficult default.
3.4 SwapClear in focus.
3.5 The picture in Paris: LCH.Clearnet SA.
3.6 Responses elsewhere.
3.7 Immediate Lessons from the default
3.8 LCH.Clearnet stands the Test
Part II: The Road to central counterparty clearing
Chapter 4 Early clearing
4.1 The first traders and post-trade practices
4.2 Clearing in the Dutch Golden Age
4.3 The spread of clearing houses
4.4 The Dojima Rice market
4.5 Forwards and Futures
4.6 Trading and Clearing Cotton in Liverpool
4.7 Futures and Clearing in Chicago
4.8 Anti-Gambling Sentiment in the US.
Chapter 5 Innovation in Europe
5.1 Breakthrough in Le Havre
5.2 The Functioning of the Caisse
5.3 Europe follows Le Havre's lead
5.4 Anti-Gambling Sentiment in Europe.
Plus a box: The Underwriters of LPCH
Chapter 6 The London Produce Clearing House
6.1 Clearing for Profit
6.2 The establishment of LPCH
6.3 LPCH - Sugar and the German connection
6.4 A divided market and a clearing competitor
6.5 LPCH and the first world war.
6.6 LPCH An awkward recovery
6.7 Forced inactivity and the sale of LPCH
Chapter 7 Complete clearing in America
7.1 The Minneapolis Clearing Association
7.2 Minneapolis: a neglected innovator
7.3 The gradual spread of complete clearing
7.4 A CCP for the CBOT
7.5 The Board of Trade Clearing Corporation
7.6 Prosperity and Depression.
7.7 Global Postscript: Separating the weak from the strong
Part III: Formative Years
Chapter 8 The collapse of Bretton Woods and the invention of financial futures
8.1 The Return of Peacetime and Economic Growth
8.2 LPCH resumes clearing
8.3 New activities and the coming of computers
8.4 Floating currencies and financial futures
8.5 Options, interest rate futures and cash settlement
8.6 The Influence of Regulators
8.7 Horizontal Integration for US Equities Clearing
8.8 Financial Futures in the UK
8.9 CCP Failures
Chapter 9 The 1987 Crash, Regulation and CCPs
9.1 The 1987 Crash.
9.2 US responses
9.3 Cross margining, TIMS and SPAN
9.4 Near disaster in Hong Kong
9.5 The Collapse of Barings
9.6 The Reaction of Regulators
Chapter 10 Continental Europe - CCPs in the slipstream of exchanges
10.1 Acronyms in Abundance
10.2 European Union, EMU and Europe's Single Market
10.3 Three Exchange Leaders
10.4 Corporate manoeuvring in France
10 5 Eurex and Clearnet
Chapter 11 Users and Clearers
11.1 User governed CCPs in the UK and US
11.2 The UK: From ICCH to LCH
11.3 New Products: RepoClear and SwapClear.
11.4 The creation of DTCC
11.5 The Options Clearing Corporation
Part IV- CCPs in a decade of boom and bust
Chapter 12 Shapers of change
12.1 Challenges of the new millennium
12.2 Users demand lower Costs
12.3 IPOs for financial infrastructures
12.4 Europe's Divisive Consolidation of Post-Trade Service Providers
12.5 The non-appearance of Transatlantic Clearing Solutions
12.6 Regulators torn between Safety and Competitiveness of Financial Markets
12.7 Financial innovation.
12.8 Concentration among clearing members
Chapter 13 The Chicago Roller Coaster
13.1 Common clearing for screen based traders
13.2 Marry in haste repent at leisure:
13.3 CBOT and BOTCC on different trajectories.
13.4 The Ascent of the CME.
13.5 After the CFTC's decision
13.6 Vertical Integration and open interest
Chapter 14 Risks and Opportunities
14.1 The need to mitigate risk
14.2 Operational risk and 9/11
14.3 International standards for CCPs
In a box: CPSS IOSCO Recommendations for CCPs
14.4 Conflict and innovation in Asia
14.5 Enron, ICE and clearing OTC energy derivatives
14.6 OTC problems
14.7 A CCP for Credit Derivatives?
Chapter 15 Cross Border Clearing in Europe
15.1 CCPs for Equities
15.2 Clearnet: Europe's first cross-border CCP
15.3 LCH and Clearnet consider marriage
15.4 The Quest for a single central counterparty
15.5 LCH and Clearnet finally merge
Chapter 16 Post-Trade Policy in Europe
16.1 Fragmented Regulation: the example of LCH.Clearnet
16.2 The first drafts of EU post-trade policy
16.3 The ESCB/CESR Standards
16.4 The EU Commission moves towards Legislation
16.5 McCreevy pushes for an industry solution
16.6 Competition authorities against vertical silos
16.7 The eclipse of the single CCP
16.8 Interoperability on the Menu
16.9 The Code of Conduct
16.10 Problems with the Code of Conduct.
Chapter 17 LCH.Clearnet under threat
17.1 David Hardy departs
17.2 Tupker and Liddell take command.
17.3 Turquoise and EuroCCP.
17.4 ICE, Liffe, Rainbow and the LSE.
17.5 LCH.Clearnet seeks safety with others.
17.6 Vertical Ascent.
17.7 TransAtlantic perspectives
Part V New Paradigms: Clearing after the Crisis
Chapter 18 Controlling OTC derivatives .
18.1 Too Big and Too Interconnected to Fail.
18.2 Clearing as high politics.
18.3 Activism at the New York Fed
18.4 Mistrust across the Atlantic and inside the EU
18.5 Working Together
18.6 Twin tracks towards Legislation
18.7 The Pittsburgh Consensus
18.8 Setting Boundaries
Chapter 19 Clearing Swaps
19.1 New products, new contenders, new horizons.
19.2 Clearing Credit Derivatives
19.3 DTCC and LCH.Clearnet unveil their merger plan
19.4 The Lily Approach
19.5 The battle for LCH.Clearnet
19.6 Hostilities Subside
19.7 Rivals to SwapClear
19.8 Security for the Buy-Side
Chapter 20 Exchanging places
20.1 Competition, Proliferation and Expansion.
20.2 Falling fees for clearing European equities
20.3 Clearing algorithmic and high speed trading
20.4 Interoperability in Europe: Progress and Setback
20.5 NYSE Euronext plans its own European clearing houses
20.6 Challenges to the CME
20.7 Clearing at the LSE: symptomatic for an industry in flux
20.8 A different future for LCH.Clearnet
Chapter 21 The Way Forward
21.1 The Dodd-Frank Act
21.2 ‘Emir' : The draft European Markets Infrastructure Regulation
21.3 Basel III and CCPs
21.4 Contemplating CCP failure
21.5 CCPs spread around the World
21.6 An Asian Century for Clearing Houses?
Chapter 22 Reflections and Conclusions
Appendices
i) References and Bibliography
ii) Glossary
iii) Abbreviations
Index