What's the value of the ICAP/MTS repo indices in the market?

Last week ICAP and MTS announced a new series of repo indices, the RepoFunds Rate. These indices are based on overnight GC and selected collateral transactions on the BrokerTec and MTS platforms, with futures to come later. We pose the question, is this new index series additive to the market or just competition for the DTCC GCF Repo Index (R) series with its associated NYSE Liffe futures? Our analysis is below.

The most obvious differences between the indices are geography and specificity, and here is where the argument can be made that each product has its own place in the market. The DTCC GCF indices focus only on the US, and more than that, focus only on three CUSIPs, according to the DTCC website: “(1) U. S. Treasury < 30-year maturity (371487AE9); (2) Non-Mortgage Backed U.S. Agency Securities (371487AH2); and (3) Fannie Mae and Freddie Mac Fixed Rate MBS (371487AL3).” The paper in each bucket is clearly homogeneous. Data on all the indices are at the same link.

The ICAP/MTS indices provide a country-level details, with the first indices focusing on Germany, Italy and France. That kind of focus is excellent for the diversity of government-backed securities found in Europe. However, the CUSIPs are much more general than for the DTCC product. The RepoFunds Rate methodology says that “Repo collateral to be any bill, bond, floating-rate note or inflation-linked bond issued by the sovereign government of the relevant country.”

While we can appreciate putting everything together to generate sufficient liquidity, we’re a little wary about putting all government issuances into one pot to generate the rates. Will this set up cheapest to deliver optionality? We like the DTCC product for its exactness in what you are getting. The European indices seem a bit looser, even though theoretically the same country’s issues ought to trade in the same patterns. If we were going to use this index for a product we’d want to keep a close eye on ALL the inputs of the RepoFunds Rate to see what we were getting into.

Both products agree that their repo transactions need to be centrally cleared. Indicative quotes are not part of the deal. According to the ICAP press release, “RepoFunds Rate is based on centrally cleared, electronically executed one business day repo transactions rather than indicative quotes. These are based on a common settlement date and will include all Overnight, Tom-Next and Spot-Next trades in both General Collateral (GC) and filtered specifics in order to more accurately reflect the effective cost of Repo funding for trades executed on both BrokerTec and MTS.” DTCC says that “In addition to the rates, the charts also show the par value, that is, the total nominal value of GCF Repos submitted each day for clearing to Fixed Income Clearing Corporation.” Everyone is on the same page there.

Where the indices start to differ more meaningfully is in liquidity. The European indices are hovering between Euro 30 billion and Euro 70 billion a day. While the DTCC Agency index is in the same range, the 30 year Treasury repo index is more around US$210 billion. This is a pretty big jump, especially when juxtaposed to Fed Funds which may be down to US$50 billion a day in actual liquidity. European investors and traders may be comfortable with the liquidity trade off, but it should be noted.

We think that the ICAP/MTS indices will achieve critical mass and find a European audience as their reference rates are most relevant for local activity. At the same time, we’d like to see more CUSIP-level or ISIN-level specificity on the products that make up the RepoFunds Rates, as well as more liquidity in the underlyings. That would give investors more certainty that their new benchmark rates are rooted in solid ground.

For more on repo rate benchmark issues, see Finadium’s August 2012 report, “Repo Indices, Overnight Index Swaps and Other Alternatives to LIBOR.”

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