Could US CCPs pay 25bps on cash collateral at today’s interest rates? The plot thickens

In new rules on Financial Market Utilities (FMUs), including the largest US CCPs, the Federal Reserve said that FMUs could open bank accounts at the Fed and get paid interest. Following the paper trail, we see that that Fed interest rate is currently 25 bps in today’s very low interest rate environment. This could become a competitive advantage for US CCPs over their international rivals.

Here’s how this works out:

In the PDF of a news release, “Federal Reserve Board announces final rule regarding Federal Reserve Bank accounts and services for financial market utilities designated as systemically important,” released on December 5, 2013, the Fed said that “proposed § 234.7(b) provides that interest paid by a Reserve Bank on balances maintained by a designated FMU in its Reserve Bank account shall be at the rate paid on balances maintained by depository institutions or another rate determined by the Board from time to time, not to exceed the general level of short-term interest rates.” The Fed has adopted this rule.

A look at the Fed’s H3 December 5 2013 release, “Aggregate Reserves of Depository Institutions and the Monetary Base,” shows the rate paid on balances. The interest rate paid on balances to satisfy reserve bank requirements is 25 bps. That’s the same as Interest on Excess Reserves (IOER), but it doesn’t have to be.

And who are the Financial Market Utilities in question? The list of eight includes the CME, DTC, FICC, ICE Clear Credit, NSCC and the OCC.

The ability of US CCPs to pay a relatively high interest rate on cash balances could become a competitive advantage. Most likely, any CCP earning 25 bps on cash balances received by clients and kept in an account at the Fed would have some kind of service charge, arguably 3-5 bps (or 10 bps, as a colleague of ours thinks). But even then, 20 bps is a lot higher than the 7-11 bps that overnight government bond repo pays these days and a great deal relative to the 5 bps paid by the Fed’s own reverse repo program (we know – CCPs don’t have access to that program – this is just for comparative purposes). It is higher than the 0 bps that some CCPs earn by keeping client cash on the Central Bank balance sheets: no risk but also no return. It is also about on par with what US money market funds can earn by following 2a-7 rules, albeit by taking market risk.

It looks like US CCPs have been offered something like the best of both worlds. They will now be able to keep their cash at the Fed, arguably the best bank in the business from a risk perspective, and earn above-market returns relative to the Fed’s risk profile. Not a bad deal at all.

The Fed release on banking services has some other interesting side-notes, particularly any conflict that a Fed account might have with netting or a bankruptcy proceeding. There were no new rules on these matters but the ideas behind the Fed’s thinking were worth reviewing.

The Federal Reserve’s release on banking services for FMUs is here.

The current Federal Reserve’s H3 release is here. Readers can find the December 5 2013 release by searching on Release Dates.

The list of US FMUs is here, courtesy of the Financial Stability Oversight Council.

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