All aboard the liquidity train
16 September 2014
LCH.Clearnet鈥檚 new Term 拢GC product aims to reduce the current operational
and risk inherent in managing gilt general collateral repo transactions
Image: Shutterstock
With the baseline figure for the European repo market being set at 鈧�5.782 billion as of 11 June, it appears that the market has resumed its gradual trend back towards normality as banks reduce their reliance on central bank liquidity.
But Godfried de Vidts, chairman of the International Capital Market Association鈥檚 European Repo Council, whose survey produced the baseline figure, warned: 鈥淲hile policymakers turn their attention to growth, it is of utmost importance to take into account potential counterproductive regulatory initiatives that risk curtailing the liquidity and fluidity of collateral, the basic ingredient of the repo market.鈥�
In one European market, changes are afoot to turn the repo market into one uninhibited by cumbersome restrictions and unnecessary risk.
Bank England governor Mark Carney declared in October 2013 that the central bank is 鈥渂uilding a liquidity framework for the markets of tomorrow鈥�. In January of this year, it took a step in that direction with the launch new regular market-wide Indexed Long-Term Repo (ILTR) operations, as it bids to increase the availability and flexibility of liquidity insurance.
In a nutshell, the new ILTR auctions provide more liquidity at cheaper rates, longer maturities and against a wider range of collateral than previously available. They are also responsive to market conditions, with the amount of liquidity available rising automatically if there is greater demand, in contrast to the fixed-size or full allotment auctions of before.
The Bank of England has also encouraged market players to innovate in the repo space, with LCH.Clearnet, Euroclear UK & Ireland (EUI) and the London Money Market Association (LMMA) teaming up to launch a new product to enhance the central clearing of gilt general collateral repo trades.
Term 拢GC (the 鈥溌ｂ�� should be pronounced, 鈥淪terling鈥�) will reduce the current operational and risk inherent in managing gilt general collateral repo transactions, according to John Burke, executive director of fixed income at LCH.Clearnet.
The new service will be based on LCH.Clearnet鈥檚 existing RepoClear Sterling GC product but will settle at EUI using its term delivery-by-value (DBV) product. At the moment, settlement of RepoClear Sterling GC trades of any term is currently conducted daily on an overnight basis via 鈥榬olling鈥� DBV transactions at EUI, says Burke.
鈥淭he current need for market participants to re-instruct settlement on a daily basis creates a lot of operational risk. A two-day trade, for example, requires the parties to instruct settlement on each day, and, in addition to being quite a burdensome exercise, can result in operational risk and settlement risk. RepoClear Sterling GC, settling using EUI鈥檚 delivery-by-value settlement mechanism is an important product for us in the UK. A lot of balances, or value, in repo trades, is expressed in that particular form.鈥�
鈥淲e鈥檝e now developed a product, Term 拢GC, to sit on top of EUI鈥檚 new DBV infrastructure called term DBV. While the two products will co-exist for a time, our goal is to have only one clearing product that sits atop this Term DBV settlement framework. By concentrating our cleared activity into the Term 拢GC product in future, it will avoid a fragmentation of liquidity and help the market to achieve a deeper and more concentrated pool of liquidity.鈥�
Trades in Term 拢GC will be executed on repo automated trading systems and via voice brokers. Building on the introduction in April of RepoIQ, the value-at-risk based margin methodology for the fixed income service, LCH.Clearnet also supports a margin offset for Term 拢GC against trades in specific UK gilts.
The timetable for implementation of Term 拢GC will come in two parts, says Burke. First to move over from Sterling GC to the new product will be new trades. This should happen in Q4 2014.
Any open positions in Sterling GC will be switched to Term 拢GC in 2015, adds Burke.
John Trundle, CEO at EUI, commented: 鈥淸Term 拢GC] reduces liquidity risks and increases operational efficiencies in the money market. Risk reduction and efficiency in the markets we serve are the core purposes of EUI so we have been pleased to develop our delivery by value collateral services in this way.鈥�
鈥淭he new term arrangements, including collateral optimisation and substitution, have enabled the market to move away from the daily roll-over of cash and collateral to an efficient process where the requirements to settle securities are aligned with the maturity of the underlying general collateral transactions.鈥�
The introduction of Term 拢GC 鈥渘ot only benefits the gilt repo market because it reduces risk, it also enhances liquidity management and just as importantly provides a clear financial stability benefit for the whole market,鈥� added Ian Mair, chairman of the LMMA.
Collaboration made easy
The new product is the result of a two-year collaboration between LCH.Clearnet, EUI, the LMMA and the Bank of England. 鈥淭his is an important project because it demonstrates that by working together, we can deliver infrastructure change in a smarter way,鈥� says Burke.
鈥淎lthough there can be a clear market need, it is not always easy to align the relevant stakeholders to achieve a change within a timescale that suits all parties. It鈥檚 natural for companies to have different priorities, particularly during time of market stress.鈥�
Burke adds that working together meant that EUI鈥檚 design for the settlement system made it easier for LCH.Clearnet to engineer a smart clearing product that dealers would want to use and the market would be confident in. 鈥淚f the product reduces operational risk in UK settlement infrastructures, then this benefits regulators and the wider market.鈥�
鈥淚s this the future? Yes and no. Most of the time, the private sector will seek to innovate and push things forward. That鈥檚 good, but there are times when you want to make a change with other stakeholders, to maximum the benefit and the impact of the change. You make a judgement on each project and this is one example of where collaboration was entirely appropriate.鈥�
鈥淚f it鈥檚 a complex product, with upstream and downstream activity, all the market benefits from our taking a step to reduce risk rather than waiting for a mandate.鈥�
But Godfried de Vidts, chairman of the International Capital Market Association鈥檚 European Repo Council, whose survey produced the baseline figure, warned: 鈥淲hile policymakers turn their attention to growth, it is of utmost importance to take into account potential counterproductive regulatory initiatives that risk curtailing the liquidity and fluidity of collateral, the basic ingredient of the repo market.鈥�
In one European market, changes are afoot to turn the repo market into one uninhibited by cumbersome restrictions and unnecessary risk.
Bank England governor Mark Carney declared in October 2013 that the central bank is 鈥渂uilding a liquidity framework for the markets of tomorrow鈥�. In January of this year, it took a step in that direction with the launch new regular market-wide Indexed Long-Term Repo (ILTR) operations, as it bids to increase the availability and flexibility of liquidity insurance.
In a nutshell, the new ILTR auctions provide more liquidity at cheaper rates, longer maturities and against a wider range of collateral than previously available. They are also responsive to market conditions, with the amount of liquidity available rising automatically if there is greater demand, in contrast to the fixed-size or full allotment auctions of before.
The Bank of England has also encouraged market players to innovate in the repo space, with LCH.Clearnet, Euroclear UK & Ireland (EUI) and the London Money Market Association (LMMA) teaming up to launch a new product to enhance the central clearing of gilt general collateral repo trades.
Term 拢GC (the 鈥溌ｂ�� should be pronounced, 鈥淪terling鈥�) will reduce the current operational and risk inherent in managing gilt general collateral repo transactions, according to John Burke, executive director of fixed income at LCH.Clearnet.
The new service will be based on LCH.Clearnet鈥檚 existing RepoClear Sterling GC product but will settle at EUI using its term delivery-by-value (DBV) product. At the moment, settlement of RepoClear Sterling GC trades of any term is currently conducted daily on an overnight basis via 鈥榬olling鈥� DBV transactions at EUI, says Burke.
鈥淭he current need for market participants to re-instruct settlement on a daily basis creates a lot of operational risk. A two-day trade, for example, requires the parties to instruct settlement on each day, and, in addition to being quite a burdensome exercise, can result in operational risk and settlement risk. RepoClear Sterling GC, settling using EUI鈥檚 delivery-by-value settlement mechanism is an important product for us in the UK. A lot of balances, or value, in repo trades, is expressed in that particular form.鈥�
鈥淲e鈥檝e now developed a product, Term 拢GC, to sit on top of EUI鈥檚 new DBV infrastructure called term DBV. While the two products will co-exist for a time, our goal is to have only one clearing product that sits atop this Term DBV settlement framework. By concentrating our cleared activity into the Term 拢GC product in future, it will avoid a fragmentation of liquidity and help the market to achieve a deeper and more concentrated pool of liquidity.鈥�
Trades in Term 拢GC will be executed on repo automated trading systems and via voice brokers. Building on the introduction in April of RepoIQ, the value-at-risk based margin methodology for the fixed income service, LCH.Clearnet also supports a margin offset for Term 拢GC against trades in specific UK gilts.
The timetable for implementation of Term 拢GC will come in two parts, says Burke. First to move over from Sterling GC to the new product will be new trades. This should happen in Q4 2014.
Any open positions in Sterling GC will be switched to Term 拢GC in 2015, adds Burke.
John Trundle, CEO at EUI, commented: 鈥淸Term 拢GC] reduces liquidity risks and increases operational efficiencies in the money market. Risk reduction and efficiency in the markets we serve are the core purposes of EUI so we have been pleased to develop our delivery by value collateral services in this way.鈥�
鈥淭he new term arrangements, including collateral optimisation and substitution, have enabled the market to move away from the daily roll-over of cash and collateral to an efficient process where the requirements to settle securities are aligned with the maturity of the underlying general collateral transactions.鈥�
The introduction of Term 拢GC 鈥渘ot only benefits the gilt repo market because it reduces risk, it also enhances liquidity management and just as importantly provides a clear financial stability benefit for the whole market,鈥� added Ian Mair, chairman of the LMMA.
Collaboration made easy
The new product is the result of a two-year collaboration between LCH.Clearnet, EUI, the LMMA and the Bank of England. 鈥淭his is an important project because it demonstrates that by working together, we can deliver infrastructure change in a smarter way,鈥� says Burke.
鈥淎lthough there can be a clear market need, it is not always easy to align the relevant stakeholders to achieve a change within a timescale that suits all parties. It鈥檚 natural for companies to have different priorities, particularly during time of market stress.鈥�
Burke adds that working together meant that EUI鈥檚 design for the settlement system made it easier for LCH.Clearnet to engineer a smart clearing product that dealers would want to use and the market would be confident in. 鈥淚f the product reduces operational risk in UK settlement infrastructures, then this benefits regulators and the wider market.鈥�
鈥淚s this the future? Yes and no. Most of the time, the private sector will seek to innovate and push things forward. That鈥檚 good, but there are times when you want to make a change with other stakeholders, to maximum the benefit and the impact of the change. You make a judgement on each project and this is one example of where collaboration was entirely appropriate.鈥�
鈥淚f it鈥檚 a complex product, with upstream and downstream activity, all the market benefits from our taking a step to reduce risk rather than waiting for a mandate.鈥�
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