Ahead of Finadium’s Rates & Repo Europe conference next week, we speak with our panelist experts from Eurex and State Street about why clearing is important for Europe and what’s in it for clients.
Cleared structures provide capacity, risk and rate benefits and will continue to grow in importance, particularly as regulators usher in new clearing mandates, said Cassandra Jones, managing director and EMEA head of Financing Solutions Client Management at State Street. Jones has been with State Street for seven years, moving to London from Boston some four years ago to build out the repo business in EMEA, and now covers agency lending, repo and the prime brokerage business in her current role.
After the 2008 global financial crisis, there was a regulatory push towards clearing for risk transfer and margin, focused on over-the counter trades, she noted: “Clearing is important for the safety of the markets, and for clients in particular because of their access to liquidity. A clearing house has many different participants able to come in and access cleared repos in a centralized way with risk transfer to the clearing house.”
In the US, Sponsored Repo has become the largest counterpart for US money funds, with some $500 billion in aggregate trading volume every day in the FICC Sponsored program. This is just starting to take off in size in Europe, said Jones.
“The market strains over year end and quarter ends are really due to banks and broker dealers adjusting their balance sheet regulatory requirements, and by doing repo in a cleared structure they are able to limit the impact that a repo transaction has on their balance sheet,” she explained. “Clients are able to access more capacity and more liquidity in a cleared structure than they would in a bilateral trade. To be able to pool liquidity into something like a cleared platform across these various markets has been really impactful for our clients, particularly over year and quarter ends.”
Clearing complexity
Client clearing is important for Europe because it harmonizes and simplifies access to repo across numerous jurisdictions and resulting fragmented infrastructures, said Frank Odendall, head of Securities Financing Product & Business Development at Eurex.
“There’s a difference in legal systems across Europe, different credit risk, collateral, those are all things that are distinct by country,” he said, adding that a central counterparty (CCP) plays a role in credit risk and counterparty risk mitigation in that context, as well as efficiency of settlement and standardization.
Still, even the most efficient set up cannot counter negative rates, which created an attractive borrowing rate for repo. That tide is changing now, Odendall said, and has been changing dramatically over the last few quarters as interest rates rise: “The biggest change we’ve seen (is) the return of a real market, and nobody knows whether everybody will be ready to operate in this new environment.”
When it comes to buy-side access to cleared repo, Eurex initially focused on pension funds, particularly those with LDI (liability driven investment) mandates, which are managed primarily in Netherlands but also Denmark, Odendall explained.
After pension funds, the insurance sector geared up on the back of rising costs of funding, and most recently hedge funds have come on board due to volatility in rates and dealer balance sheet constraints. Odendall also noted that there is an expansion of product availability, and the clearing of repo has moved beyond government bonds: on a daily basis there are transactions in corporate and covered bonds as well as SSAs (sovereign supranational agencies).
“The directional uses of derivatives, Uncleared Margin Rules, and the upcoming mandatory clearing of OTC IRS (interest rate swaps) caused a lot of concern around liquidity, cash management, capacity, timely availability of funding,” he said. “Time after time, CCP-cleared repo over the last 20 years has shown resilience in any type of market disruption.”
Not just for the largest players
Clients typically identify key benefits in terms of operational efficiencies, because they can do a large amount of business within minutes from trading to settlement. Eurex Repo has some 150 participants that includes central banks, supranationals and financing agencies, Odendall noted, of which a hundred members are trading at different times of the month. This translates to a diversity of potential counterparties, compared to the average buy-side firm’s typical five to ten counterparties for bilateral trading.
“Many buyside firms think they are not large enough to participate because they think that the operational burden is so huge, and the money required to invest to implement this is so high, that it’s not worth it,” he said.
“This is changing. Yes, it’s effort to implement this, but we have a lot wider use cases for ever increasing opportunities (and) it’s not restricted to the super large pension fund managers, the very well capitalized insurance companies. Smaller, medium leveraged entities can now access it.”
Cassandra and Frank will be sharing their expertise on the Client Clearing in 2023 panel, joined by colleagues from LCH and AXA Investment Managers, as well as industry expert Richard Comotto at Rates & Repo Europe, a conference for cash investors, dealers, market intermediaries, technology firms and other service providers. Other panels will consider Liquidity conditions in the UK and Eurozone with BlackRock, Citi, GLMX, HSBC, J.P. Morgan and Natixis and Post-trade Technologies and Business Opportunities with BNY Mellon, EquiLend, Euroclear, MarketAxess, and Pirum.