How would you describe European securities finance at the moment?
Securities finance markets are under significant pressure from regulators. A drying up of the fixed income market, combined with scarcity of high-quality liquid assets (HQLA), has put further pressure on repo markets.
SIX Securities Services has seen indications that repo volumes are falling in the market and is looking ahead to the next International Capital Market Association (ICMA) survey to establish whether or not this is a continuing trend on the horizon. Our repo arm—SIX Repo—has been resisting this trend however, by keeping volumes steady, in fact, even increasing volumes over the past two quarters across a number of currencies, particularly the euro (EUR) and the Swiss france (CHF). The move of the Swiss National Bank on 15 January to abandon the currency alignment to the euro and the introduction of negative rates at -75 basis points has further pushed volumes up.
Securities finance still lies at the core of financial markets and provides a crucial backbone to the smooth functioning of capital markets as a whole—despite the plethora of regulation directly and indirectly affecting securities markets, it has held up a lot better than expected.
The regulatory environment is likely to create new opportunities within the securities finance space—collateral upgrades and downgrades, for example, are likely to become traded more actively than activity levels today would suggest, as firms short of HQLA will need to borrow or buy those assets to cover shortfalls.
In addition, the European Market Infrastructure Regulation (EMIR) and the Financial Market Infrastructure Act (FinfraG), the Swiss equivalent regulation, will drive over-the-counter (OTC) derivatives business to central counterparties (CCPs), which, in turn, will require more and higher-quality collateral, further fuelling demand and driving securities finance markets to support transformation trades.
At SIX Securities Services, we have now rolled out our securities finance offering CO:RE (collateral and repo) for integrated securities finance services, including brand new trading platform capabilities, which will roll out in Q1 2016, in addition to the existing and reliable triparty functionality.
Recent market volatility, particularly on the equity markets, may throw up challenges with regards to increased margin call activity. This could challenge the overall robustness of the market, although at SIX Securities Services we run a robust mark-to-market process many times a day ensuring that even a volatile market environment does not pose any challenges to our participants and to the wider market.
Where are you seeing demand and supply coming from in securities lending in Europe, and are we back to pre-crisis levels? What about the repo business?
Overall volumes have been recovering but have not achieved the pre-crisis levels, both in the repo and securities lending markets. In fact, a dichotomy has appeared between the US and European repo markets since the 2008 financial crisis. The US repo market shrank from a pre-crisis peak of approximately $7 to $10 trillion, to only $3.88 trillion in October 2014, according to Federal Reserve research.
The European repo market, on the other hand, has been more resilient. Although it did not reach the pre-crisis peak of €7 trillion, it shrank at a lower rate. However, volume growth in the European market over the past two quarters was flat, and in fact was slightly down when looking at the last two ICMA surveys from June and December 2014, which constitutes a decreasing trend that is partly due to tightening regulation and resulting increases in capital costs.
Within the repo market, SIX Securities Services has seen some trend changes in the type of business that is conducted. Drivers differ across currencies and curves, but, for example, the CHF repo market has seen a lot of movement around the negative rate of -75 basis points. While the volumes at which the negative rates apply are individually based on the underlying institution, this also provides ‘gaps’ between the so-called free amount available to one single institution—no negative charge and negative rate applied. This has led to some lively activity with regards to ‘topping up’ the free amount and creating funding and trading opportunities for institutions in the market. This is just one example of the change in trading patterns that SIX Securities Services has observed in the repo market.
Additionally, there appears to be an increased interest from the non-bank sector to get involved more directly in the traditional inter-bank repo market, particularly from the institutional buy side and asset management and, indirectly, the pension fund market. Some of this stems from the current rate environment in Switzerland, Europe and the US.
The search for increased yield drives some of those institutions to seek access to cheap, fast and large liquidity pools to ensure funding access at all times while still being able to have a higher proportion of assets invested longer term. On the other hand, demand from the institutional banking side for stable and long-term cash balances generates interest for the corporate sector to move in to the market and provide such funding.
What is SIX Securities Services doing to meet the changing needs of securities finance participants in Europe?
SIX Securities Services is building on its existing strong client relationships to further those relationships and support client needs across the whole value chain of securities finance transactions. Furthermore, closer involvement with its clients through a bi-annual advisory board, in order to exchange the latest trends and ideas as well as possible product enhancements, further strengthens the client relationship and closeness to the market. Providing more tailored services away from over-standardisation further strengthens SIX Securities Services client and market engagement.
In a challenging economic environment, the SIX Repo market provides some rather unique characteristics: for example, applying no haircuts to the standardised basket trading while continuously achieving a settlement rate of 100 percent. Further, we provide an on demand service—repo on demand—which also supports equity-driven repo transactions, special baskets, and so on.
There are numerous initiatives currently undertaken at SIX Securities Services to adapt the product chain and make it future-proof for all the challenges that we believe lie ahead.
SIX Securities Services is also actively present at all major industry forums and conferences, tracking current developments in the market and engaging with academia and the press to remain focused on all the developments in the securities finance arena.
How are repo participants being challenged at this moment in time, and how is SIX Securities Services helping them?
Current challenges for our repo participants come from two main directions: regulation on the one hand, and the general market situation on the other.
With regards to regulatory developments, Basel II and Basel III are weighing in on the capital cost side of the business. The liquidity coverage ratio is affecting repo trading, particularly the length of term.
At SIX Securities Services we are in the process of rolling out a new trading platform, expected in Q1 2016, that will support enhanced functionality to support the increased challenges of our clients to manage the increased complexity and regulatory framework of repo transactions.
Additionally, the current interest rate environment in Switzerland (-75 basis points) also poses separate challenges for our clients. In a wider context, FinfraG will affect clients soon as the initial implementation date is set for 1 January 2016.
For the term of a repo, SIX Securities Services provides comprehensive and fully automated risk management. How does this work?
SIX Securities Services provides a fully automated risk management service in its repo triparty transactions. In order to ensure the right level of collateralisation, SIX Securities Services undertakes a twice-daily mark-to-market with movements of collateral when required.
A third mark-to-market happens in the evening, which does not include any collateral movements.
The whole SIX Securities Services repo market is underpinned by a triparty agent function and all concluded transactions are passed over to the triparty agent, which significantly reduces the operational risks normally associated with concluding the business.
This ensures an almost seamless transaction for all parties.
The triparty agent always ensures that the exposed party—be that on the cash or collateral side—is always covered.
Furthermore, the triparty agent ensures that any collateral with pending corporate actions is automatically substituted where possible before any of the corporate actions are due, therefore avoiding any possible withholding tax implications and further improving the ease and efficiency of repo transactions.
Uniquely on the European repo platform and infrastructure landscape, SIX Securities Services allows for full re-use of collateral outside of its environment while still ensuring a settlement rate of 100 percent.
What are the biggest changes you have witnessed in collateralisation in securities finance?
SIX Securities Services has seen an increase in demand for the collateralisation of derivatives instruments, particularly OTC derivatives on the FX futures side as well as some demand for exchange-traded derivative collateralisation. For the past few years, SIX Securities Services has been working closely with CCPs in Europe and with the Swiss insurance market to create an EMIR- and FinfraG-compliant platform that will manage increasing collateral requirements in a more efficient manner. This approach from SIX Securities Services offers one of the highest forms of asset protection for underlying insurance firms and their corresponding funds.
To achieve such a sophisticated protection model, SIX Securities Services has tied up with CME Clearing Europe in the first instance of its kind to offer an integrated service for the collateralisation of the initial margins required in centrally cleared derivatives transactions such as interest rate swaps and credit default swaps.
Beyond this, SIX Securities Services’s segregation capabilities continue to support both individual and omnibus account structures as various client requirements. CCPs such as CME Clearing Europe and SIX X-clear are already committed, and we are in ongoing discussions with other CCPs that hold, or want to hold, collateral with SIX Securities Services in the form of high quality securities on behalf of banks and institutional clients.
What about CCPs?
SIX Securities Services is constantly in contact with its clients to evaluate the trends and requirements in the market. While CCP uptake in the repo market has somewhat evolved over the past years, we do not see the same trend on the securities lending side. In our set-up, we currently do not use a CCP and provide a focus on the platform within the bilateral market, which also provides access to central bank intra-day funding as well as access to the spot market auctions that the Swiss National Bank conducts from time to time. We do have a CCP within the Swiss value chain and we provide triparty services for a number of other CCPs, including the UK-based clearinghouse, CME Clearing Europe.
We see the trend of triparty usage for CCPs increasing further and leading to closer collaboration. The regulatory costs imposed by Basel III (among others) will certainly create an increased demand for CCP securities finance transactions. Not least because of the differing capital cost treatments that will increasingly manifest themselves—some which already have—as we move closer to the implementation date.
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