Clearing Services for Global Markets A Framework for the Future Development of the Clearing Industry_4 pot

4 Collecting empirical insights – introduction to the empirical study To gain insight into the practical relevance and nature of the different cost categories for various clearing member types as well as to derive a basis for analysing the impact network strateg ies have on clearing costs, the author conducted a comprehensive original empirical study. The original study was also necessary because relevant cost data is not publicly available, and pub- lished evidence is scarce at best. Additionally, as the European Commission has observed, ‘[t]he pricing of post-trading services is complex. Several studies have attempted to shed some light’. 1 Nonetheless, as outlined in section 1.2, none of these studies delivers a universally accepted and accurate description of clearing costs. 2 This study’s original empirical component therefore serves to provide the necessary basis for analysing the costs of derivatives clearing in general and the efficiency impact of European network strategies in particular. The aim of this chapter is fivefold: to describe the underlying data (section 4.1); to detail the method of data collection and explain the process and timeline of the empirical study (section 4.2); to present the study’s structure and component parts (section 4.3); to describe the data treatment and interpretation (section 4.4); and to discuss the quality of the expert inquiry (section 4.5). Finally, a summary is provided on the purpose and use of the empirical insights (section 4.6). 4.1 Underlying data The empirical study consists of seventy-nine interviews conducted with vari- ous stakeholders in clearing. As outlined above, the development of the clear- ing industry is of importance to all clearing stakeholders, which constitute a heterogeneous group. Although the focus of this research is on determining 1 European Commission (ed.) (2006e), p. 1. 2 Cf. European Commission (ed.) (2006e), p. 1. 120 Clearing Services for Global Markets COLLECTING EMPIRICAL INSIGHTS – INTRODUCTION TO THE EMPIRICAL STUDY Underlying Data 4.1 4 PURPOSECHAPTER Introduces the original empirical study which was conducted to obtain insight into the transaction costs of clearing as well as to derive a basis for analysing the impact that network strategies have on clearing costs. Describes the underlying data. Details the method of data collection and explains the process and timeline of the empirical study. Presents the empirical study’s structure and component parts. Describes the data treatment and interpretation. Discusses the quality of the expert inquiry. 4.2 Method and Process of Data Collection Structure of Empirical Study4.3 Data Treatment and Interpretation Quality of Expert Inquiry Summary on Purpose and Use of the Empirical Insights 4.4 4.5 4.6 Figure 4.1 Structure of Chapter 4 the costs of clearing from the perspective of European-based clearing member firms, a restructuring of the European clearing industry ultimately requires the involvement, cooperation and support of all of the different stakeholders. Consequently, it was considered necessary to include representatives from the various public and private stakeholders in the sample in order to achieve a more comprehensive view on integration and harmonisation initiatives within the clearing industry. Potential respondents were consciously selected 3 because the nature of the empirical study required detailed insight into the subject of clearing, both from a cost management and a more strategic per- spective; seniority was thus considered a prerequisite. The conscious selection of individuals with a suitable background also served to reduce the num- ber of rejections that a r andom selection or inquiry within firms might have incurred. On the other hand, such a conscious selection of respondents entails a lengthy and time-consuming process: firstly, a long list of public and private stakeholder entities in clearing was compiled; secondly, suitable indiv iduals within these entities were identified; and thirdly, relevant contact information was collected. The conscious selection process led to a high positive response rate of suitable respondents, but was not without inherent limitations. The 3 The selection process to find interviewees can be either random or conscious. Refer to Schnell/Hill/Esser (2005), pp. 297–300, for details on the advantages and disadvantages of both methods. 121 Collecting empirical insights – introduction to the empirical study 58 Empirical Study Clearing Members NCMs Market Experts Clearing Houses Exchanges Regulators Contacted Confirmed 21 (36%) 20 8 (40%) 39 28 (72%) 99(100%) 14 10 (71%) 43 (75%) Combined Average Annual European Cleared Market Share: ~60% No. of Interviewees Interviewee Groups TOTAL 144 79 (55%) Figure 4.2 Empirical study – positive response rate of contacted individuals according to interviewee groups Source: Author’s own. maximum number of identifiable suitable individuals within stakeholder enti- ties as well as access to relevant personalised contact information both posed limitations. Time and cost issues also came into play, because the data was mainly collected via interviews held in person. 4 In the end, 144 individuals representing different stakeholder groups were contacted. Figure 4.2 provides an overview of the response rate and divides the con- tacted individuals into six so-called ‘interv iewee groups’: clearing members, non-clearing members (NCMs), market experts, clearing houses, exchanges and regulators. The clearing member respondents, who were critical for obtaining detailed and diversified insight into the costs of European derivatives clear ing, repre- sented the coreinterviewee group. The individuals representing clearing mem- ber firms constituted a representative sample of the first level of the European VPN. The list of clear ing members is publicly available on the European clearing houses’ websites. For the purpose of this study, the focus was put on contacting clearing members of LCH.Clearnet Group and Eurex Clearing. A total of fifty-eight individuals were contacted: twenty-one represent high volume clearers, thirteen represent medium volume clearers and twenty-four represent low volume clearers. Positive response rates were as follows: 4 For the reasons for conducting personal interviews and for details on the process of data collection, refer to section 4.2. 122 Clearing Services for Global Markets r high volume clearers: twenty-one contacted; thirteen confirmed (i.e. sixty- two per cent); r medium volume clearers: thirteen contacted; five confirmed (i.e. 38 per cent); and r low volume clearers: twenty-four contacted; three confirmed (i.e. 13 per cent). The high positive response rate on the part of high volume clearers suggests that this group is highly interested in the subject of this research. Indeed, many of the individuals contacted from this group had been actively engaged in restructuring the European clearing industry through participation in inter- est groups, lobbying activities, publication of art icles or papers, speeches and panel participation at international industry conferences, interviews in rele- vant publications, etc. Some representatives of medium volume clearers had also publicly pronounced their interest in the issues of clearing efficiency and the future structure of the industry, but the same cannot be said about the individuals representing low volume clearers contacted for the study. The dis- parit y may in part be explained by the fact that most high and many medium volume clearers employ dedicatedmanagers, to whom the issue of clearing is of strategi c value. On the other hand, most low volume clearers tend to be much smaller in size; they consequently tend to have leaner management teams that are devoid of managers with a strategic interest and detailed cost view on clearing. Clearing is, after all, more of operational than strategic importance for most low volume clearers. 5 Additional factors might have influenced the response rates of the different clearing member types. Whereas twenty-one clear ing members were ultimately interviewed, the above-mentioned response rates show that the empirical study is biased towards the view of high volume clearers. The combined European cleared market share in exchange-traded derivatives 6 of the twent y-one interviewed clearing members equals roughly 60 per cent. 7 The comparatively large number of NCM representatives (eight out of twenty) who agreed to contribute to the empirical study was surprising at first. As NCMs only have indirect access to the clearing house, it was assumed that entities with direct access to the CCP would generally be more concerned about the transaction costs associated with clearing. The possible reasons and 5 Details regarding the relevance of clearing costs and the impact of different network strategies on the different clearing member types are analysed in the remainder of this study. 6 This estimate refers to Europe’s five major derivatives clearing houses: LCH.Clearnet, Eurex Clearing, OMX Clearing, MEFF and CC&G. 7 The estimate of combined European cleared market share is based on information provided by Eurex Clearing AG. LCH.Clearnet refused to comment on the correctness of the estimate. 123 Collecting empirical insights – introduction to the empirical study Empirical Study – Number of Interviewees per Location London: 1 Cont EU: 1 US: 1 London: 2 Cont EU: 3 US: 5 London: 1 Cont EU: 2 US: 6 London: 9 Cont EU: 4 US: 15 London: 5 Cont EU: 0 US: 3 London: 9 Cont EU: 7 US: 5 London: 27 Cont EU: 17 US: 35 3 109288 21 79 London: 1 EU: 1 US: 1 London: 2 EU: 3 US: 5 London: 1 EU: 2 US: 6 London: 9 EU: 4 US: 15 London: 5 EU: 0 US: 3 London: 9 EU: 7 US: 5 London: 27 EU: 17 US: 35 31092882179 Clearing Members NCMs Market Experts Clearing Houses Exchanges Regulators TOTAL Figure 4.3 Empirical study – number of interviewees by group and location 8 Source: Author’s own driving factors for the interest shown by NCMs in the subject of the research are further analysed in the remainder of the study. The group of market experts encompasses a variety of different stakehold- ers, such as former executives of clearing houses, exchanges and financial ser- vice providers, as well as former regulators. Representatives of banks/brokers (which are not clearing members of European derivatives clearing houses), interest groups, industry associations, academics, lawyers and central bankers are also included in this interviewee group. As the contacted individuals were carefully selected with regard to their background and interest in the research area, this explains their willingness (and high positive response rate) to con- tribute to the empirical study. Finally – and not surprisingly – clearing houses, exchanges and regulators all showed great interest in the focus area of the research. As outlined in section 2.4, these stakeholders have a natural interest and significant stake in the core issues analysed in this study. The only group of pr ivate stakeholders deliberately excluded from the empirical study was CSDs/ICSDs, because they generally play a less important role in the life cycle of a derivatives trade and because their current focus is on the consolidation of the securities settlement industry. Because this analysis centres on the integration and harmonisation of European CCP clearing, these stakeholders were not asked to participate in the empirical research. 9 The individuals who contributed to the empirical study were located in Continental Europe (Belgium, France, Germany and Switzerland), London and the US (Chicago, New York and Washington). Figure 4.3 shows the number of interviewees per group and by location. 8 EU: Continental Europe representing Belgium, France, Germany and Switzerland. 9 Another group of public stakeholders that did not provide input to the research is European policymakers. Although four policymakers were contacted and two of them provided feedback on the research goal and structure of this study, a formal interview ultimately did not take place. 124 Clearing Services for Global Markets The rationale for including these different European interviewee locations was twofold: firstly, it was felt that the most important home markets of Europe’s two major CCPs (Eurex Clearing and LCH.Clearnet) should be included in the study. Secondly, a large number of suitable experts and pro- fessionals in clearing turned out to be located in London; this is reflected in the fact that more interviews were conducted in London than in Continental Europe. The US was included because any effort to integrate and harmonise the European clearing industry will ultimately be global in scope. Therefore, and because the US clearing industry is often referred to as a role model for Europe, it was considered necessary to include US-based interviewees. Fur- thermore, for some of the selected clearing member firms, the management concerned with the strategic and cost issues of clearing happens to be located in the US. The five clearing member representatives based in the US are all clearers maintaining a direct clearing relationship with LCH.Clearnet and/or Eurex Clearing through their European subsidiaries. 4.2 Method and process of data collection To generate the empirical data, an expert-interview-based approach was employed to obtain qualitative insights; the interviews were complemented with quantitative data from a questionnaire. At the initial contact, stakehold- ers were asked to give an interview. The data-gathering approach was to firstly conduct an interview in person and then distribute the questionnaire at the end of the interview. The rationale for pursuing this approach (rather than a purely questionnaire-based a pproach or sending out the questionnaire prior to the interview) was based on the partially explorative angle of this research, the nature of the respondents and the type of empirical insight desired. Whereas a purely questionnaire-based approach might have generated a larger sample size, this approach was not suited to this study’s research objec- tive. Due to the complexity of the research question and the general lack of publicly available studies, data and insight, a semi-structured approach was chosen to afford more flexibility as well as the ability to actively steer the course of the investigation. This enabled greater responsiveness to the respondent’s background and his or her feedback. Seniority was a prerequisite in the selection of interviewees. Most of the individuals who participated in the empirical study were thus senior managers in the first or second management level. It was assumed that these managers generally have neither the time nor inclination to fill out questionnaires; 125 Collecting empirical insights – introduction to the empirical study it was also supposed that these managers would see no particular reason and would thus most likely not be willing to delegate the completion of the questionnaire to their team. Prior interaction was therefore considered essential for conveying the benefits of contributing to the research and to enhance the interviewees’ understanding of the nature and purpose of this study. It was hoped that this would serve to encourage the respondents to provide further input (i.e. beyond the expert interview) as well as facilitate the collection of quantitative cost data. Ultimately, however, the greatest hurdle was presented by the strictly confidential nature of the cost data that was sought from clearing members. Managers were expected to be unwilling to agree to the release of such sensitive data to an unknown third party. It was therefore considered essential to establish a personal relationship with the interviewees beforehand in order to reassure them of the anonymity and confidential treatment of any submitted data prior to asking for concrete cost data and distributing the questionnaire. However, even then, the undertaking of collecting clearing cost data was prone to difficulties. Ultimately, the author conducted seventy-nine interviews. Although the majority of interviews were one-on-one, three interviews with two respon- dents and two interviews w ith three respondents were conducted. All inter- views but one were conducted orally, 10 with 94 per cent of all interviews (seventy-four of seventy-nine) held in person with the author of this study. Four interviews were conducted via phone by the author and one in writ- ten form via e-mail. The majority of interviews, namely sixty-three out of seventy-nine, were conducted in English. The remaining sixteen interviews were conducted in German. The process of data collection took place over a period of three-and-a- half months, according to the following timeline: from early February to early March 2006, interviews with London-based respondents proceeded. The interviews with respondents based in Continental Europe were conducted thereafter. Finally, from early April to early May 2006, US-based participants were interviewed. In May 2006, further interviews w ith respondents based in Continental Europe were performed. The interviews took between thirty minutes and two-and-a-half hours, depending on the time granted for the interview as well as the particular respondent’s manner of expression and knowledge of the issues. The majority of interv iews took place once, although in some cases, follow-up questions 10 In one case, the interview guide was sent electronically to the respondent, who then provided written answers to selected questions. 126 Clearing Services for Global Markets were asked subsequent to the interview, or additional information was pro- vided via phone or e-mail. Prior to the interv iew process, the respondents were assured of the anonymity of their participation, i.e. that no information, be it quantitative or qualitative in nature, would be published in a way that would identify or provide a direct reference to their person and/or company. Any input provided by the interviewees was therefore made anonymous; the completed questionnaires and interview transcripts are therefore not publicly available. Whenever an interviewee is identified by name in the remainder of this study, prior consent was obtained from the respective individual. Any views expressed by the interviewees are their own and do not necessarily represent the official stance of their organisation. The interviewees are not associated with the final conclusions of this study. The findings of this study do not necessarily reflect the views of the individuals interviewed in the context of this study. The majority of the oral interviews were recorded on tape or digitally (sixty- five out of seventy-eight). In thirteen cases, the interviews were not taped. In six of these cases, the interviewees declined to have the conversation taped; the other seven interviews could not be taped for other reasons (in most cases, the meeting location was not amenable to tape recording, i.e. too much ambient noise was present or the dynamics of the interview precluded asking to tape the interview). In addition to recording the interviews wherever possible, the interviewer also took notes. 4.3 Structure of empirical study As indicated before, the empirical data collection mainly consisted of an expert-interview-based approach. In a second step, the qualitative insights provided in the interviews werecomplemented with quantitative data from the questionnaire. Although it was clear ex ante that this undertaking contained a high likelihood of failure, i.e. that the interviewees were not likely to respond to the questionnaire, it was nonetheless attempted. The main purpose of the questionnaire was to collect concrete quantitative cost data from clearing members and subsequently conduct comparative assessments of the impact of different network st rategies on the transaction costs of clearing. 11 11 Overall, the questionnaire consisted of five parts : Part 1 comprised closed questions concerning the general relevance of CCP clearing; Part 2 asked for concrete cost data and concerned the transaction cost analysis of derivatives clearing; Part 3 contained closed questions related to analysing demand- and 127 Collecting empirical insights – introduction to the empirical study The strict confidentiality of cost data accounted for the presumption of a low response rate. The attempt to collect quantitative cost data from clearing members through the questionnaire did indeed fail, as expected. For compet- itive reasons, banks and brokers acting as clearing members were understand- ably not willing to voluntarily release any such information to an outside third party – not even under reassurance of st rict non-disclosure and aca- demic purposes. Only five clearing members returned the questionnaire, but none provided concrete cost data. 12 Nonetheless, the few questionnaires that were partially filled out served to provide helpful insight regarding the case study assessment in Chapter 8. 13 Because the likelihood of failing to gather quantitative cost data via the questionnaire was expected ex ante, a ‘workaround’ enabling a cost calcula- tion was devised. The workaround consisted of collecting qualitative infor- mation in the interviews that could be used as a basis for deriving quanti- tative clearing costs in a subsequent step. This objective was consequently taken into account in the determination of the structure and questions for the interv iew guide. The interviews were semi-standardised. An interview guide tailored to each of the different interviewee groups as well as to the particular experiences and background of the respondents was developed. Adaptations were also made with respect to the interviewees’ location; a sub- set of specific questions concerned only US-based respondents, whereas other questions were only relevant to interviewees based in Continental Europe and London. Depending on the particular experience, knowledge and back- ground of the respondents, certain questions were not posed if it became clear that the interviewees would be unable to answer them. The number of questions consequently varied slightly and the order was generally not fixed (i.e. the order was adapted according to the answers provided by an interviewee). The interview guide covered questions related to the following issues: 14 supply-side scale effects; Part 4 consisted of closed questions pertaining to different industry initiatives; and Part 5 solicited basic respondent information. 12 Prior to the distribution of the questionnaire, eight test runs were conducted. Representatives of two banks and two clearing houses as well as four market experts participated in the test runs. All representatives provided positive feedback on the structure, length, style and clarity of the questionnaire. Respondents also indicated that they would be willing to fill out the questionnaire – including the part asking for cost data. Despite the positive test runs, the final response rate was as low as predicted. The bank representatives who had previously confirmed their willingness to return the completed questionnaire (including the cost data part) ultimately failed to return the questionnaire at all, even partially filled out. Whereas one bank did not provide reasons for this, the other specified that the questionnaire could not be returned due to reasons of confidentiality. 13 Refer to Appendix 4 for the questionnaire. 14 Refer to Appendix 5 for a sample interview guide. 128 Clearing Services for Global Markets 1. Introductory Questions. 2. Transaction Cost Analysis. 3. Network Strategies. 4. Efficiency Impact of Network Strategies. 5. Case Studies of Network Strategies. 6. Future Development of Clearing and Global Outlook. Although the approach of establishing a personal relationship with the inter- viewees to reassure them of the anonymity and confidential treatment of submitted data prior to asking for concrete cost data did not boost response rates to the questionnaire, it did help to ensure that respondents provided helpful feedback. This was particularly relevant for the critique of the author’s qualitative and quantitative research results subsequent to the interview pro- cess. 4.4 Data treatment and interpretation Prior to the data treatment, all seventy-nine interviews were t ranscribed. For those conversations that were not taped, an interview protocol was established; the taped interviews were transcribed verbatim. For data treatment, the pro- cedure suggested by Schmidt (1997) was used, consisting of the following four steps: 15 1. Establish categories for interview analysis. 2. Code interviews. 3. Provide quantitative overview (frequency of occurrence). 4. Interpretation. The objective of the data treatment was to identify response patterns, sim- ilarities and varieties in the answers provided in the expert interviews in order to facilitate the interpretation of the collected data. 16 To this end, cate- gories for analysing the contents of the interviews were developed according to the procedure suggested by Mayring (2007). 17 This procedure follows a three-step approach. The first step summarises the collected data, structured according to the most important contents of the interviews and utilising an interview synopsis table. The second step consists of a clarifying text analysis that elucidates ambiguous terms used by interviewees by taking into account additional material such as other interview passages or information on the 15 Cf. Schmidt (1997), pp. 544–66. 16 Cf. M ¨ uhlfeld et al. (1981), p. 334. 17 Cf. Mayring (2007), pp. 59–100. [...]... of this study The categories and category values are then used as the basis for the process of coding the interviews Coding enables the reduction of the collected data to short and comparable codes, and includes the establishment of a coding outline and the actual process of attributing data to the employed codes Due to the large amount of text, coding was carried out with the support of special data... cleared, the higher the 24 25 26 The European market share refers to the combined cleared market share of derivatives contracts cleared through Eurex Clearing, LCH.Clearnet, OMX Clearing, MEFF and CC&G An estimate of the market share of each clearing member is based on information provided by Eurex Clearing, which was extended and adapted to an estimate of an overall European market share These conclusions... on the capital structure of the clearer, the perception of cost of capital is influenced by the interviewee’s management position as well as the nature of the clearing member’s business Calculating, analysing and understanding the true cost of capital related to clearing is difficult, because it requires the individual to have knowledge about the internal rates charged by the treasury department as well... that much difference to our P&L? Hardly!42 The interviewees’ assessment of the low relevance of cost of capital was mainly based on the following arguments: r collateral-rich clearers have enough capital available; r clearing houses can serve as a cheap form of custody; and r clearing houses pay interest on most collateral The collateral-rich clearing members usually have large bond portfolios in place,... cost awareness Markets with a low number of contracts traded are less likely to be in the centre of cost considerations On the other hand, cost awareness is high with reference to high volume markets In these markets: Clearing costs can restrict the volume of trading of a broker or a bank The clearest example of that are the so-called black-box traders, who trade through an automated system, doing arbitrage... of stakeholders in European clearing Particular efforts were made to obtain a representative selection of clearing members, because their perspective is of particular importance to the study at hand; clearing costs are analysed from the perspective of clearing members The fact that the clearing members who were interviewed have a combined European cleared market share of roughly 60 per cent strengthens... Regarding product attributes, cost awareness can be correlated with a product’s life cycle In the early stages, the product is usually characterised by low market demand as well as a lack of standardised processes for clearing it 137 Analysing costs of derivatives clearing – transaction cost studies Therefore, the clearing of exotic, new or niche products often requires some form of manual interaction,... contract value In accord with the respective exchange, many clearing houses therefore offer discount clearing rates for new products See as an example OCC’s standard approach to discounts for new products at www.theocc.com/about/schedule.jsp Interview with Peter Cox 138 Clearing Services for Global Markets margins matter a lot On the other hand, retail trades are hardly ever conceptualised to make... representative Although the respondent repeatedly claimed to be unconcerned about reducing clearing costs, he did define as a business objective to enhance internal processing and leverage the back -of ce and IT infrastructure 140 Clearing Services for Global Markets transparent information sharing within the firm further complicates the task of managing and monitoring the all-in costs of clearing. 13... compared to other market infrastructure costs (such as derivatives trading costs as well as securities trading, clearing and settlement costs) to assess their relative significance 134 Clearing Services for Global Markets CHAPTER 5 ANALYSING COSTS OF DERIVATIVES CLEARING – PURPOSE Analyses the costs of derivatives clearing TRANSACTION COST STUDIES 5.1 Findings from Empirical Study 5.2 Transaction Cost Analyses . costs of clearing as well as to derive a basis for analysing the impact that network strategies have on clearing costs. Describes the underlying data. Details the method of data collection and. Empirical Insights 4. 4 4. 5 4. 6 Figure 4. 1 Structure of Chapter 4 the costs of clearing from the perspective of European-based clearing member firms, a restructuring of the European clearing industry. structure of this study, a formal interview ultimately did not take place. 1 24 Clearing Services for Global Markets The rationale for including these different European interviewee locations was twofold: