Outlook Stable for Financial Infrastructure Companies in 2018


Tuesday, November 21, 2017 4:30PM/ Fitch Ratings 

Financial market infrastructure companies' (FMIs) are sufficiently well-positioned to manage intensifying competition next year, according to Fitch Ratings' 2018 Outlook report.

Supporting the sector's stable outlook are FMIs' entrenched franchises, scale and increasingly diversified business models, which will help offset persistently lower trading volumes and increasing regulatory and infrastructure costs. Fitch defines FMIs as including exchanges, central clearing houses (CCPs) and collateral securities depositories (CSDs).

"Intensifying competition and potential scale benefits are likely to lead to further industry consolidation in 2018," said Evgeny Konovalov, Director in Fitch's Non-Bank Financial Institutions group. "Many exchanges are also seeking to expand their core franchises by adding related services." 

For exchanges, those which are more vertically-integrated are better positioned to weather competitive pressures and market fluctuations given the diversity of their revenue bases and lower correlation between business lines. However, increased merger and acquisition (M&A) activity would result in increased leverage, followed by potential de-leveraging thereafter. 

For CCPs, competitive pressures may drive initial and variation margin requirements lower, which would reduce CCPs' ability to manage losses from counterparty defaults in the event of market stress. At the same time, recent regulatory developments are likely to be moderately positive for CCPs, as the requirement for central clearing of derivatives has brought significant business volumes to the largest CCPs.

More prudent regulations and stress testing, albeit introducing additional regulatory compliance costs, may promote more robust risk controls and temper risk appetites, in Fitch's opinion.

"Fitch believes that increased alignment of interest between CCP shareholders and market participants through increased skin in the game would benefit CCPs' risk profiles going forward", said Konovalov.

For CSDs, Fitch expects profitability to remain sound in 2018. "Supportive fixed income markets and their prudent approach to ancillary business growth will allow Europe-based international CSDs to absorb still-rising costs relating to infrastructure investments like cyber risks and regulatory changes," said Christian Kuendig, Senior Director in Fitch's Non-Bank Financial Institutions group.

Fitch also expects that CSDs' risk-weighted capital ratios will remain strong in 2018. Ongoing capital generation and balance sheet optimization at commercial banks will support moderately increasing settlement volumes and growing assets under custody. European CSDs, for example, have started charging for some institutional deposits in an effort to reduce their balance sheets.

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