The Bank of England has published the minutes from its recent market update for the securities lending industry.
In the repo markets, an increase in Euro Overnight Index Averae (EONIA) volatility in January was reported, although specific reasons remained unclear. The temporary spike in the ECB standing facility to £15.7 billion in February created some market uncertainty and led to increased volatility of specials. However, this was soon reported to have been a temporary phenomenon and specials volatility returned to normal levels.
Repo volumes had been strong with an increase in short-dated repo trades on one major electronic platform from £188 billion (in Nov 2010) to £205 billion. There continued to be significant interest in Spanish bonds cleared through the LCH, with demand particularly notable in terms from one month to one year.
The RONIA (repurchase overnight index average) project was in the final stages and completion was expected later this year.
An increase in volume for 5-year term collateral upgrade trades had been seen and commented on by a number of dealers. These had generally been collateral upgrade trades in which non-government collateral was placed to insurance companies in return for government bonds under securities lending documentation.
The committee was given a paper with a presentation on the potential benefits to the securities lending market of central counterparty (CCP) clearing. The presentation drew upon a note that was prepared for the committee1. Committee members were invited to comment on whether CCP clearing could help mitigate key risks in securities lending markets; costs or risks to CCP clearing; whether there are barriers to adopting CCP clearing and how these barriers might be overcome; and whether there are other important risk factors which are not addressed by CCP clearing.
CCPs were thought to help facilitate more conservative and transparent margining practises, as hypothesised by the Bank of England note, but it was suggested that beneficial owners, for whom lending was an optional activity, could choose to withdraw from the market if lenders were margined. Committee members noted that whilst greater transparency would benefit the industry, transparency is already offered to some extent through data aggregators.
It was also noted that CCPs are potentially more capital efficient. A securities lending transaction via a CCP carries a 0% risk weight, compared to 20% on a bilateral arrangement with a bank and 100% with a pension fund.
It was thought important to consider whether a CCP clearing system would be able to process transactions on an anonymous platform or bilaterally, or a combination of the two. It was also noted that while the CCP?s credit intermediation function allows participants to trade anonymously, such anonymity is not always preferable with securities lending. Furthermore, multiple CCPs would be needed to cover the range of markets in which securities lending activity takes place requiring contributions to multiple default funds by lenders.
Some SLRC members considered that adverse consequences arising from the implementation of CCPs in the near term could be a risk. Those members thought it better to allow them to find an appropriate place in the market in the medium – long term. Committee members highlighted some potential concerns about the use of CCPs. One was that a CCP further lengthened the long chain of intermediaries involved in securities lending. This was a concern for beneficial owners who preferred to be "closer? to their securities.
The committee was updated on recent regulatory developments in which the FSA was involved. These included an update on the short-selling regulation, which is expected to be enacted between Easter and the summer; the European Market Infrastructure Regulation (EMIR) for clearing and reporting of OTC derivatives, also expected with similar timing; the MiFID and MAD legislative proposals, anticipated for May/June; EU developments on close-out netting; and the new UK resolution framework for investment banks.
The new UK resolution regime for investment banks – the Investment Bank Special Administration Regulations 2011 – will appoint an administrator to address the return of client assets and to work with markets to deal with failed trades. The EU work on close-out netting, which forms part of a larger piece of work on resolution, aims to facilitate the resolution of a failing bank which has outstanding transactions subject to close-out netting contracts. One option being considered is to allow resolution authorities, on an EU-wide basis, to impose a 24-48hr moratorium on the exercise of counterparties? close-out rights. Its rationale is mainly to provide authorities with additional time to consider the transfer of relevant contracts as part of a resolution measure.
