The Bank of England may have gotten into the collateral transformation business…will the Fed follow?

Several news sources reported on last week’s speech by Mark Carney, the former Canadian central banker, now head of the Bank of England. Governor Carney spoke at a function celebrating the 125th anniversary of the FT.  He said a couple interesting things, not all of which were picked up in the press.

Carney emphasized that the BOE’s facilities are there to be used: “we are open for business” was his mantra. He told the audience that the rates charged on lending facilities would come down, in some cases by half.  Liquidity would be offered for longer terms. A wider range of assets would be accommodated, albeit with the caveat that the Bank would need to be able to access the risk of those assets.

On the surface, this reminds one of the ECB’s LTRO facility. It seems a bit preemptive given the weaning of banks off the LRTO and the recent growth in the European repo markets. That’s not to say there aren’t problems that central bank liquidity will help solve (or at least contain) – we think about the Italian repo market and the potential accelerant that LCH’s recent liquidation policy changes may have created for a funding crisis. But Governor Carney is getting in front of the markets in a way we don’t see very often and that certainly commands respect.

After watching the speech on YouTube (I was viewer 147 of the 23 minute speech…sorry, this one is not going viral) it was clear there was more in the speech. The news stories did not pick up on Carney emphasizing something interesting. So along with the lower rates, longer terms, and a wider range on what collateral is acceptable, Carney said they would be doing monthly repo auctions, taking in a broad range of collateral versus providing high quality assets (watch from minute 16.5 of the speech). Isn’t that the collateral transformation business? Could the BoE become a low cost source for HQLA necessary to post at CCPs and/or hold to satisfy LCR? (Note to self: That last sentence had way too many acronyms.)

Will this encourage the Fed to go down the same road? Tweaking the fixed-rate repo facility now under test to do asset versus asset deals shouldn’t be that hard. We know the Fed certainly has enough HQLA to go around. It isn’t in the regulators interest to see the repo markets become all gummed up with less liquid paper while starved for HQLA.

If collateral transformation – swapping less liquid paper that isn’t CCP eligible with securities which are eligible – starts to make serious headway, all that ineligible collateral will have to get recycled somewhere. We question if there is very deep demand from cash lenders for the funkier paper (which would need to be financed for term to avoid LCR problems). There is some time to work this out. But once European central clearing requirements kicks in, the higher bilateral collateral thresholds from IOSCO start, and central derivatives clearing in the US starts to take a bigger bite out of the collateral pool, the dynamic will change. Maybe the Fed should take a page out of the BoE’s playbook and get in front of the markets?

A YouTube link to the speech is here.

A YouTube link to a Q&A with Lionel Barber, FT editor, and Mark Carney is here.

A link to a Reuters article on the speech is here.

An article in the FT appeared on October 24th, but was behind the pay wall.


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