April 26, 2022 | Stamford, CT — Although regulators started the move to cleared derivatives, recent growth in derivatives clearing has been driven not by mandates, but by the maturing market structure. Simply put, asset managers, hedge funds and other financial users of OTC derivatives have discovered that the benefits of clearing outweigh the costs.

 Derivatives clearing has experienced consistent growth since the global regulatory mandates enacted after the financial crisis. At first, that growth was almost entirely a function of market participants altering business practices to comply with the new clearing mandate.  Over the past few years, the market has shifted into a new phase in which the growth of derivatives clearing has been largely spurred by natural market forces. 

“Although clearing comes with inherent costs like margin requirements and clearing fees, the reduction in counterparty risk and improved liquidity offered by cleared swaps have been enough to sway the majority of users,” says Stephen Bruel, Senior Analyst for Coalition Greenwich Market Structure & Technology and author of Incentives Drive Buy-Side Derivatives Clearing, but Challenges Remain. 

Approximately 70% of the buy-side market participants in the Coalition Greenwich 2021 Derivatives Market Structure Study cite reduced counterparty risk as the primary reason for clearing. Users are also being drawn to clearing by liquidity. 

“Market practices and the economics of clearing are maturing,” says Stephen Bruel. “This enhances the virtuous cycle, in which more clearing will bring more liquidity, which will bring more participants over time.”

Maintaining Growth 
To continue growing, clearing brokers will have to ensure that market participants are offered compelling incentives to clear more and different types of trades. This will require operational improvements and new efficiencies. Clearing brokers recognize they need to invest in key areas, including client service, providing access to new products, and their own internal workflows. For example, operational improvements that allow them to more quickly locate and settle margin may enable a broker to improve their capital usage and improve client service.

Brokers cite asset managers and hedge funds as their key client bases when it comes to the profitability of their clearing business. 

“While asset managers are currently the most important customer segment for the profitability of the business, hedge funds are seen as presenting the biggest opportunity for new business going forward,” says Stephen Bruel.

Incentives Drive Buy-Side Derivatives Clearing, but Challenges Remain identifies what market participants see as the primary incentives and disincentives to clearing, and analyzes the primary drivers of future growth, including both customer types and products. The report also addresses the important issue of broker defaults and portability, and outlines steps clearing brokers are taking to maintain growth.