The old English proverb “there’s many a slip between cup and lip” aptly describes the state of play after recently announced plans to broaden access to collateral in the European repo market by 2015.
Amid great fanfare, it was announced in recent weeks that the International Capital Market Association (ICMA) European Repo Council, Clearstream, Euroclear and Eurex Clearing will look to widen access to GC Pooling, the Deutsche Börse-owned leading pool of liquidity for secured funding in euros and dollars.
The parties have signed a memorandum of understanding (MoU), the primary aim of which is to bring Euroclear Bank into the previously siloed complex comprising Eurex Clearing, Clearstream and the GC funding pool.
In simple terms, the MoU is potentially a great opportunity for Euroclear and its customers, giving them access to Europe’s biggest collateral pool, comprising some 8,000 securities, resulting in increased efficiency and reduced costs.
However, the benefits for Eurex are less clear cut, the main one perhaps being recognition that GC Pooling has become the dominant provider of liquidity in European repo markets.
“What this shows is that GC Pooling is the platform of choice for the European market,” says a source connected to the negotiations. “The ICMA and Euroclear have been pushing for this and yes it’s an important element, but from an economic perspective it doesn’t make a huge difference to Eurex.”
If negotiations in the coming two years are successful, the bottom line is that Deutsche Börse will have been persuaded to give up one of its precious product siloes.
Under the current system, customers wishing to access GC Pooling must use the Eurex repo trading platform for repo transactions, following which, after netting and novation, assembly of Euro GC collateral is executed within the group and is delivered through group systems.
For Euroclear customers, that has meant manually delivering baskets of collateral to a DB Group (Clearstream Luxembourg), which assembles the basket and delivers it to Eurex Clearing.
Under the planned changes, baskets will be automatically assembled and delivered by Euroclear tri-parties directly to Eurex Clearing via Clearstream Frankfurt, the local central securities depository for Eurex.
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| Saheed Awan, of Euroclear |
“This will make it much easier for market participants using Eurex’s GC Pooling to use assets they hold with Euroclear Bank as collateral for Eurex margining,” says Saheed Awan, global head of collateral management and securities finance at Euroclear. “Eurex will also see the benefit of increased collateral automation via this direct link with Euroclear Bank, which could provide significantly more business than they see today.”
Before the new system can be put in place, there is a sizeable task of bringing settlement systems together.
The key difference is that at Eurex Clearing, settlement happens in central bank money, the preferred method of settlement for Target2-Securities, the new European securities settlement engine which aims to offer centralized delivery-versus-payment (DvP) settlement in central bank funds.
At Euroclear, settlement is in commercial bank money.
“In commercial bank money DvP settlement, firms call upon intraday credit lines at Euroclear Bank or Clearstream Banking Luxembourg to fund their accounts, so that as soon as securities are credited, the related cash payment is made simultaneously,” says Awan.
“In central bank money settlement, firms must ensure the account with which they are purchasing securities is prefunded at the central bank. For GC Pooling collateral movements, Eurex insists that all settlement activity is done in central bank money.”
The cost of switching to a pre-funding system might be significant, says Awan, as holding cash one day before settlement is naturally expensive, and Euroclear will consult widely with clients before committing to the plans under the MoU.
“This is a different way for Euroclear Bank to operate and we are examining how central bank money settlement will work both for us and our clients,” says Awan.
Euroclear France already uses central bank money settlement.
If access to Eurex GC Pooling is opened up to other settlement houses and collateral organizations, European regulators are likely to be pleased, reflecting as it does the spirit of interoperability envisaged across European securities markets.
“The ECB has left no doubt in anyone’s mind that they are keen to see this and the basic track is that the industry has told the service providers to pull up their socks and make the exchange of collateral more efficient,” says Richard Comotto, senior visiting fellow at the ICMA Centre at the University of Reading.
“The agreement is there in principle and now the biggest remaining hurdle is probably the commercial case and whether people will take it up.”
Negotiations between parties to the MoU will commence in the coming weeks, with reporting formats, daily valuation of securities and settlement status all in the mix. They will not be completed until at least the end of the year – and only if agreement is reached and client consultations are positive will the build-phase commence.
“We will only pursue the MoU for the benefit of our clients,” says Awan. “If they don’t want all the elements of the MoU, we will re-discuss with our partners.”