Collateral correction

The market effects of monetary policy and regulation were outlined at the Deutsche Börse Global Funding and Financing Summit in Luxembourg

Liquidity, or the lack of it, was the hot topic at the newly re-branded Deutsche Börse Global Funding and Financing Summit in Luxembourg.

Conference panellist Roelof Van der Struik of PGGM, an active play in the reverse repo space, outlined concerns that month-end liquidity pools are drying up and pension funds are most at risk.

Speaking in a panel alongside a representative from the European Central Bank (ECB), Van der Struik revealed that he had found it more difficult balance the books each month in the second half of 2016, due to a lack of market liquidity caused, in part, by ECB monetary policy.

He added that the current month-end drop offs were already the worst he had witnessed during his career and that the problem was amplified significantly at year’s end.

“It’s [month-end liquidity] getting worse,” Van der Struik explained. “On average, liquidity is okay but we had some serious problems [at year’s end].”

“I really hope that some liquidity comes back to the bilateral repo market, which is being disproportionately affected. We will need this market in the future.”

The recently extended ECB public sector purchase programme was accused of being a major factor behind the repeated droughts.

When explaining its decision to extend its asset purchase programme in December, the central bank stated: “From April 2017, the net asset purchases are intended to continue at a monthly pace of €60 billion until the end of December 2017, or beyond, if necessary.”

Panellists and audience members all highlighted that a programme of this scope and duration was inevitably going to affect overall market liquidity of the high-quality liquid assets that are essential to the health of many markets, including as securities finance.

Stifling reporting requirements and unfair risk mitigation rules are also contributory factors according to conference attendees.

Data analysis from the International Securities Lending Association appears to reinforce the theory that the ECB’s prolific hoarding of government bonds, with only a limited lending programme, is a contributing factor to dwindling liquidity, according to the panel.
The ECB representative on the panel acknowledged a nominal drop in average liquidity but denied that it had sunk to dangerous levels. It was also clarified that the asset purchase programme was devolved to national central banks at an operational level, and that there was some disparity in their commitment to the programme, of which the ECB was not responsible.

“We have the feeling that the securities lending programme has been well received by the market,” explained the ECB panellist.

“We monitor our repo and securities lending programme very closely. The market needs to adapt and be innovative to survive in these difficult times.”

The ECB recently revised its lending rules for eurosystem central banks to allow for cash collateral to be reinvested more liberally, as of 15 December.

The central banks of Europe, Germany, Ireland, France and Belgium have all since opened their lending programmes to cash collateral, along with Spain and the Netherlands. The ECB set the overall limit for lending against cash collateral at €50 billion.

In a statement on the revised rules, the ECB said: “To avoid unduly curtailing normal repo market activity, the cash collateral option will be offered at a rate equal to the lower of the rate of the deposit facility, minus 30 basis points (bps), currently -70 bps, and the prevailing market repo rate.”

Turning to the regulations that are putting downward pressure on overall liquidity, the panel cited the US Federal Reserve-backed single counterparty credit limits, which are built upon the initial rules laid down in the Dodd-Frank Act. A global systemically important bank must now apply a 15-percent cap to its tier-one exposure to any other similar ranked bank, and a 25-percent cap on its tier-one exposure to other counterparties.

Several panellists noted that the limited number of counterparties in the securities lending market means that this rule disproportionately penalises their area of the market. The burdensome reporting requirements of the Securities Financing Transaction Regulation (SFTR), among other frameworks, were also held up as forces driving participants out of the market by making the cost of lending uneconomical.

Don’t shoot the messenger

The appearance of several representatives from policymakers and central banks was a welcome addition to this year’s summit that allowed for robust and frank public debate on real challenges facing the industry.

ECB board member Yves Mersch attempted to ease the concerns of the repo industry over the central bank’s controversial monetary policy during his keynote speech on the second day.

Mersch acknowledged the negative effects of the central bank’s “unconventional monetary policy”, but argued that the European repo market, by its very nature, is procyclical and so will continue to suffer for as long as it takes for the overall economy to recover, regardless of ECB policy.

“The ECB has one mandate, which is to ensure price stability,” Mersch explained.

“Elevated risks to its goal have made unconventional measures necessary on an unprecedented scale and on a temporary basis. And they prove successful. Although we try to minimise negative side effects, any of these considerations are without prejudice to the obligation to honour our mandate.”

Mersch went on to explain that, once inflation rates are back to normal in Europe, the ECB’s policies can also normalise. This includes its uncharacteristic suppression of interest rates and persistent asset purchase programme, which is now ongoing until March.

In response to concerns raised by these policies in earlier panels, Mersch echoed points raised by his colleague from the previous day’s session, who stated that, although unfortunate for some summit attendees, the ECB has to consider the wider markets when drafting policy.

“Although the asset purchase programme might have some negative side effects on the functioning of the repo market as compared to the pre-crisis levels, other more potent factors were at work. To reduce spillover effects the ECB has also introduced several mitigation measures.

Mersch, without offering a specific timeline, implied that the recovery is well underway and the end is in sight.

Hoping for a Hail Mary

The first keynote of the summit, Andreas Zubrod, member of Union Asset Management’s executive board, opened by celebrating the fact that, for the first time in years, the event would not be dominated by discussions around regulations. That didn’t turn out to be entirely true.

In a subsequent panel, when discussing the looming 1 March deadline for fresh margin rules under the European Market Infrastructure Regulation (EMIR), speakers were in agreement that a second delay is needed.

New non-cleared, over-the-counter derivatives margin rules under EMIR are aimed at reducing counterparty and credit risk. Once implemented, all new derivatives trades will need to be backed by collateral in the form of initial and variation margin to cover the risk of a counterparty default.

A snap poll of the conference hall compounded the delay prediction as only 17.3 percent claimed to be ready for the deadline. A further 35 percent said they are still putting their agreements into place, but had already completed their operational changes. Another bank representative panellist agreed with the claim that a delay was needed and stated that the 17.3 percent result was a surprisingly positive figure.

Despite the lack of industry preparation, many audience members and panellists were not hopeful that a delay is coming. The rules were originally intended to rollout throughout the EU back in September, but a delay pushed that back to the March. The US, Canada and Japan all managed to meet the initial deadline and went live in September.

The Financial Stability Board first warned of the global market’s inability to meet the deadline in August 2016, as part of its review of 24 markets’ progress. The review found that 10 countries were unlikely to be ready for implementation in the first half of 2017, while eight would not reach completion within the year.

Easy as CCP

The mantra, “it’s a marathon, not a sprint”, has never been truer than when describing the introduction of central clearing to securities lending, but the finish line appears to be at hand.

Another audience poll revealed that 43 percent of those in attendance who had considered alternative routes to market had looked into using a central counterparty (CCP).

The significance of this was emphasised by panellist Susan O’Flynn of Morgan Stanley, who notes that pro-CCP responses to this question had been around 20 percent in previous years.

Speaking after the panel, Marcel Naas, global head of funding and financing at Deutsche Börse Group, added: “[The] poll result is a positive affirmation that Deutsche Börse’s continuous strive to deliver industry standard solutions has been well received by the securities lending community. We will continue our endeavours to become a leading provider of services that understands and fulfils clients’ needs.”

Another Eurex representative, when also commenting on the poll, noted that, in a wider context, if just under half of a market which boasts €1.9 trillion of securities on-loan, as of 30 June 2016, are considering utilising a CCP solution, it represents a significant opportunity for Eurex and its partners.

G20 and counting

Godfried De Vidts, chair of the International Capital Market Association European Repo and Collateral Council captured the mood of the day in his closing remarks.

“After the Lehman Brothers event, it was clear that regulation of the secured markets was necessary, hence the overall direction of travel is not a problem for market participants,” he said.

He called on market participants and regulators alike to work together to ensure that at appropriate regulatory framework is constructed to avoid repeating the events of 2008.

“However, more work is needed to make sure that the repo and collateral market can deliver what is intended of it. Hence, several calibrations of current initiatives are urgently needed, for example to alter net stable funding ratio asymmetries; the Central Securities Depositories Regulation mandatory buy-in; Markets in Financial Instruments Directive best execution (which should be shifted to SFTR, where market participants are working hard to develop usable reporting); use of collateral for CCP and bilateral clearing; and to further refine the lending programme under qualitative easing.”

De Vidts continued: “Particularly after the year end turmoil, that will continue albeit to a less punitive extent, it is important that the fluidity of collateral–the flow of cash and collateral in the system–is at the service of both sell- and buy-side market participants. The negative impact on the real economy is now plain to see. We owe it to all, and see it as our duty, to make sure that collateral flows, mainly through the repo market, are put back on track, so the ultimately goal of the G20, to avoid yet another crisis, can be best realised.”
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