London-based Catalyst Development Ltd, market leaders in clearing, risk and regulation, have issued an advisory briefing for hedge funds explaining how they can save $ millions each year through a brand new approach to trade compression, re-engineered specifically for the hedge fund market. Catalyst believe action is urgently required if funds are to withstand major increases in clearing broker fees as the European Clearing Mandate comes into force in early 2016. Catalyst’s approach is outlined in the attached white paper ‘OTC IRS Portfolio Optimisation: how trade compression could save hedge funds $ millions before the 2016 European Clearing Mandate strikes.’

Catalyst’s extensive experience working with futures commission merchants and clearing brokers has led them to conclude that broker fees will need to increase an estimated eight to tenfold as the consequences of leverage ratio and post crisis reform begin to bite.  In their opinion, the collision of a number of key factors is set to compound the impact for hedge funds. In particular:

• the European Clearing Mandate is set to apply early in 2016 and the US Mandate is already in force.  Hedge funds must access these services.
• the Basel III leverage ratio requires banks to optimise capital: they can no longer afford to offer broker services at a loss. Several have already dropped out of the market with more set to follow. Those who remain will be targeting a 14% – 15% return on capital, up from the current 1% – 2%.
• MiFID II sets the stage for Organised Trading Facilities (OTFs), which will drive a wedge between the traditional cross-subsidy from execution to clearing.

Tom Lodge

Tom Lodge, Catalyst Partner and the paper’s lead author comments “We believe a perfect storm is building and we are advising all funds trading IRS at volume to use 2015 to maximise their trading and clearing efficiency before the European Clearing Mandate comes into effect. The ideal solution is compression. Historically however, this has been seen as relevant only to the sell-side: to date, hedge funds have lacked bespoke tools that allow intra-fund netting and compression while keeping individual strategies flat. We have therefore re-engineered netting and compression for the hedge fund market.  Our unique approach allows any hedge fund trading IRS at reasonable volume to save approximately 80% of clearing broker fees and thus tens of $ millions each year, by optimising the use of market compression solutions and eliminating excess gross notional from their book.  On top of these savings, it also allows funds to make additional savings of $ 3 million a year in lower execution costs.”

Catalyst’s white paper  ‘OTC IRS Portfolio Optimisation: how trade compression could save hedge funds $ millions before the 2016 European Clearing Mandate strikes” is written by Catalyst Partners Tom Lodge and Stephen Loosley with expert Sean Coote.