In the June 16, 2015 FT there was an article by Joe Rennison and Philip Stafford, “LCH.Clearnet sounds alarm over declining use of repo” (sorry behind the pay wall) that highlighted the difficulty LCH.Clearnet is having investing cash margin. It got us thinking….
From the article:
“…One of the world’s biggest clearing houses has warned it may soon reach the limit of its ability to use the short-term financing market to park its collateral as banks are squeezed by tougher regulations…”
and
“…LCH.Clearnet, the world’s largest interbank swaps clearer, said there may be limits to the amount of customer margins it can send to the repurchase, or repo, market as regulation constrains customers…”
The capacity constraints facing the repo market have been in the news more and more. Leverage issues have forced banks to clamp down on businesses that use a lot of balance sheet without earning much return.
LCH.Clearnet invests $150 billion of client cash and putting it to work in repo feels a lot better than many of the alternatives. From the article:
“…European regulation prevents them holding more than 5 per cent of the cash they receive from clients unsecured, so they exchange it for short-term bonds — a move known as “reverse repo”…”
In Europe, the problem is compounded by PSPP draining HQLA (sorry…acronym overdose) from the markets and making life difficult for repo traders. We wrote about that on April 22nd in “The European repo market is singing the QE blues.”
So what might LCH.Clearnet do? We wonder if LCH could help broker/dealers by making their repo trades balance sheet netting friendly? The best way to do that might be routing them through a repo CCP….like LCH.Repoclear. Could LCH.Clearnet become a member of LCH.Repoclear? We didn’t see their name on the membership lists.
In the U.S., could LCH become an eligible Fed RRP counterparty? They would certainly be a place to invest cash. Regulators wouldn’t complain about the risk concentration. Maybe LCH could deposit the cash at the Fed and earn IOER? Are there other alternatives that CCPs have for investing their cash? How about they sign up as a cash provider for DTCC’s (soon to be) expanded GCF program?
We have to wonder if LCH.Clearnet has so much cash margin because of the shortage of eligible HQLA forcing their members into cash or if the members simply prefer using cash? What is the mix between initial and variation margin anyway (the latter is always cash, the former can be a mix of eligible assets and cash)? We think that cash is king because it is easier to manage and less a function of HQLA collateral scarcity, but that feels like a minority opinion these days.