Global Funding & Financing Summit 2021
16 February 2021
Deutsche Boerse’s first virtual GFF Summit brought together securities finance professionals to discuss the state of the market in 2021
Image: Elnur/stock.adobe.com
Panel one: To clear or not to clear?
Deutsche Boerse’s discussion focused on the development of central counterparties (CCPs) and posed the question: to clear or not to clear? The panellists were unanimous in their answers: maybe.
Elaborating, speakers representing buy and sell-side market participants, explained that when asked whether to clear repo, factors including what type of transaction it is, what side of the street you’re on, whether you’re looking to give or receive cash and, crucially, the market environment and level of volatility at the time all played a part in how to answer the session’s central question.
Taking the past 12 months, panellists noted that the decision to send repos through a CCP has fluctuated in lockstep with the market’s volatility as overall liquidity and the economics of bilateral versus cleared trading shifted.
The growing volume of transactions put through CCPs such as Eurex has been a clear trend in recent years but the volatility seen in 2020 and particularly March and April offered an ideal case study for when the costs of a clearinghouse are worth it for netting efficiencies and security.
Eurex Repo saw term-adjusted volumes jump 10 per cent year-on-year in 2020, including a 39 per cent and 29 per cent YoY increase in GC Pooling and Repo markets in March, respectively.
The panel agreed that the benefits of clearing during market stresses are solid, but whether clearing repo will break out of the ‘use in case of emergency’ mould and build a use case for day-to-day activity was a key area of debate.
Setting the scene, the panel moderator acknowledged the modest but steady growth in cleared repo among the largest sell-side institutions in the US but went on to probe panellists on why the uptake for sponsored repo by buy-side members has not seen a significant uptake so far.
There is roughly $5 trillion in US treasury repo outstanding at any given time. In comparison, only $300 billion is cleared through sponsored repo, Inglis highlighted.
In response, sell-side panellists emphasised that sponsored repo was only one piece of the total repo market and has evolved in recent years.
In 2018, the panellist conceded, the Fixed Income Clearing Corporation’s (FICC) US treasury repo clearing programme had limited activity. Since then the volume has grown between 10-15-fold due to key changes to the model, including expanding the membership.
The joining criteria for sponsored members and sponsoring members now includes all qualified institutional buyers instead of only registered investment companies. Expanded requirements for sponsoring members means the broker-dealer community have joined well-capitalised custody banks. Additionally, FICC adapted the programme from overnight to term and made it a two-way flow to allow repo and reverse repo.
According to a fellow sell-side panellist, this has led to more than 20 members providing sponsors today, up from only three in 2018.
The first speaker explained further how although the average notional volume might be $300 billion, during the COVID-19 volatility period in March and April 2020, the volume hit a high of $550 billion.
“Central clearing is in the toolkit to be utilised when needed,” they explained. “When there was volatility in the market and a need for capacity you saw people accessing this programme.”
The speaker added: “Buy-side clearing doesn’t seem like it’s at critical mass at this point but if you look at the evolution over the past couple of years you’re seeing an increase which points to the fact this is becoming a tool both sell and buy-side are using to create efficiencies and for safety.”
Reviewing the past year, another speaker reinforced the point that the market environment will impact the economics of cleared repo and will therefore drive demand.
“If you can buy treasury bills that offer higher yield than repo then you will. But we are now seeing repo start to overtake bills so we will see the market revert back,” he explains.
However, a panellist representing a buy-side firm that does not clear repo offered a different perspective.
According to the speaker, their firm’s abstention from clearing repo is due in part to the different economics depending on whether you’re a cash giver or taker. The concept of clearing was created when cash was king, which is no longer the case.
“No one wants cash, it’s persona non grata, you can’t place it anywhere which is why money market and treasury funds are being pushed into clearing to gain access to counterparts,” the speaker explained. “I’m sitting on the other side of that and paying for that leverage which is extremely cheap and available today, which you can see from the crunch that didn’t happen at the end of 2020.”
For as long as cash is so accessible it will be cheaper and easier to trade bilaterally, the speaker stated, but went on to acknowledge a future scenario where central bank cash is less available than today and her counterparts reduce their balance sheet availability, inverting the market dynamic.
“The economics must be considered on a case-by-case basis and I will only ever see clearing as part of my toolkit and not my defined route of trading,” the panellist concluded.
Turning to the equity market, the moderator noted Eurex is building out its capabilities in this area, as is the Depository Trust and Clearing Corporation, and invited panellists to offer predictions of whether clearing of equities can match the growth in fixed income.
A speaker representing a major US bank said what he sees in the fixed income space makes him hopeful for equities, both in securities lending and repo products, as he believes in the merits. However, he also echoed the reservations, stating that the cost-benefit analysis for clearing equities is still not good enough for many of his clients.
“Those costs and the model are proving to be challenging right now. We are working through those but fundamentally that’s a challenge,” he said.
In addition, the panellist admitted to being worried that the journey to CCP adoption is still suboptimal in most cases.
“If I look at the hundreds of clients in my bank’s agency lending programme and lay at their doorstep a stack of lending agreements, some will be comfortable with them but not all will be,” he said. “To gain further adoption we need to ease the on-boarding process. We are working on it but it is still early days in this process.”
Looking ahead, when questioned on where the clearing space may be in five years time, the buy-side panellist said she’s confident derivatives, particularly those that contribute to gross notional for regulations such as the Uncleared Margin Rules, will increasingly be put through a CCP.
“It gives you the benefit of liquidity and access, as well as reducing the need to post initial margin bilaterally, which is pretty painful,” they said. “But, on the repo side I don’t think we are there and there’s a further evolution of the model that needs to happen for it to be one everyone can have access to.”
A fourth speaker representing an asset manager that is currently onboarding with Eurex is more bullish. He explains, as a cash giver, that clearing short-dated repo is expected to be a structural part of how the firm runs its cash portfolio. More generally, the speaker said cleared volumes will benefit from increased standardisation in the market, such as with collateral baskets. Like the other panellists, the buy-side speaker implored CCPs to put every effort into minimising the paperwork needed to onboard and said streamlining this process will likely contribute to a volume uptick.
Apart from the CCPs themselves, panellists cited regulators and incoming regulation as additional drivers of clearing adoption. When describing the rush to FICC’s repo programme in 2020, a sell-side speaker said that “during that volatility regulators want to ensure there is safety, soundness, liquidity and resilience in the market and utilising the programme resonates on all those points”. The speaker went on to predict that the combination of market pressures and approval of CCP use from regulators will eventually make clearing an everyday tool as opposed to just one used to mitigate heightened volatility.
Reinforcing this, the second sell-side speaker added that regulations including Basel IV, which has implications for the risk weighting of counterparts, will make trading through a CCP more attractive.
To clear or not to clear is, it seems, a perennial question both within firms and across the securities finance market that must be asked repeatedly and often. Whether it’s driven by a need for liquidity, resilience, regulation, balance sheet efficiency, or all of the above, every time it is posed more of the industry appears to have made a clearinghouse a home.
Panel two: Repo and securities lending: what to expect
Any prediction about what to expect in the year ahead must be made in the context of the year just gone, panellists agreed. The pandemic brought severe volatility to equity markets and a decade of post-crisis regulation to the ultimate test.
As the dust settles and the world appears to be heading towards a post-COVID environment, securities finance market participants are now able to assess the lessons of 2020 and take stock of whether their technology and innovation strategies are still optimal.
Reviewing the fallout of the March-and-April volatility, the panel moderator questioned whether the securities finance market is mispricing risks.
A panellist suggested that 2020 changed the risk landscape by ratcheting up many new factors in addition to the normal financial risks, including several non-traditional exposures such as reputational risk and legal risk.
The major differences between the 2020 volatility and previous crises is that the financial risks going into March were low as banks generally had stronger balance sheets than years gone. Additionally, the market shock was caused by a healthcare issue, not a financial one, which has in part allowed for a rapid recovery only months after the initial shock.
Compared to the 2008 financial crisis, or even in September 2019 when the repo markets had a wobble, last year market overseers were quick to mitigate liquidity issues to such a degree that a panellist questioned whether repo markets are “too comfortable” due to implicit backstops.
An abundance of cash in the market naturally drives a hunt for yield, the speaker said and warned that too much of this trend could create a race to the bottom, which must be avoided.
“It’s important to still apply fundamental risk metrics, examining counterparties, asset mixes and adjusting and reconfirming views frequently,” they stated.
Another panellist added: “The industry’s risk management skills were put to the test in 2020.”
Liquidity risk emphasised by the spike in margin calls hammered home the importance of repo and secured financing markets which are intertwined with collateral and derivatives markets, he argued.
Secondly, settlement frictions also became apparent, noting “we have this global infrastructure which works fine during normal times but when we hit these periods of stress it really does start to creak”.
“We need to look for solutions that enable us to move collateral and liquidity around the globe during all the currency timezones and jurisdictions,” the speaker mused.
Thirdly, the panellist highlighted counterparty risk while acknowledging that the market appeared to be mobilising to prevent defaults by assisting in meeting margin calls, a very different reaction to previous crises when haircuts increased sharply and ensured troubled entities were drowned in capital demands.
“We are not even 12 months past the volatility last year and haircuts are around the lowest they’ve ever been while spreads are also very low so we need to watch that stretch on risk and reward,” he concluded.
The moderator followed this by asking if these concerns amounted to an argument for minimum haircuts. The speaker responded that the Financial Stability Board has done a lot of research into this question and minimum haircuts might help but went on to argue more emphasis should be placed on the models for making sure market participants are “thinking very carefully about the risks they are taking”.
Turning to the future and comparing US and EU repo markets, an EU-based speaker predicted that changes to balance sheet reporting and leverage ratio calculations under Basel III will impact the market landscape.
From March, US banks will begin applying capital charges and will be required to report a daily snapshot of their balance sheet as opposed to a quarterly report, with European banks applying a similar system from January 2022.
“There’s no doubt that because European banks have so far been managing their balance sheets on quarter-end this will reduce the amount of balance sheet available for clients,” he said.
The speaker noted that US rule changes contributed to an increase in sponsored repo volume and suggests the same may occur in Europe.
“The new rules are a good development that will help market stability enormously,” added a panellist. “Some of the temporary leverage ratio exemptions have added capacity for banks to provide liquidity and it’s really important that they aren’t constrained from providing liquidity against high-quality liquid assets from a risk-weighted asset perspective.”
However, he noted, moving liquidity away from banks and into a direct clearing system only shifts the problem. Banks need to be allowed to lend responsibly as that’s the only way the market can wean itself off the central banks, he affirmed.
The European panellist concurred and argued that the financial market community should not give up the fight in lobbying for government bonds to be permanently excluded from the leverage ratio “to keep the stability and good functioning of the markets”.
The future is digital
According to a different panellist, the future is digital, but foundations for widespread adoption are not yet firmly established.
The standardisation of data, legal hurdles and the technology infrastructure that surrounds it are all areas that must be addressed before widespread adoption can be achieved, he said.
The implementation of the Securities Financing Transactions Regulation revealed “an industry-wide failure” as firms tried to communicate with each other with “wobbly standards” that prevented them from effectively sharing information both externally and internally.
A lack of standardisation with credit ratings, ISINs and legal entity identifiers (LEI) is undermining efforts to allow for the free-flow of data, he explained.
Preliminary data from a market survey by several trade bodies, including the International Securities Lending Association (ISLA), indicates that there are more than 49,000 securities within the securities finance ecosystem that were reported to have a variety of LEI issues.
The speaker emphasised the conclusion first made at the 2020 Securities Finance Times Technology Symposium that the CDM and blockchain are “a match made in heaven” but reiterated that the foundations of good data husbandry must be in place first.
“By the end of this year, once these blocks are in place, both ISLA and the International Capital Market Association will be in a position to have something that firms can start adopting,” the panellist said. “This time next year we will have a much clearer view about what the impact of these initiatives will be.”
A separate speaker reinforced this point, noting that when distributed ledger technology (DLT) was first introduced it was touted as a grand solution to very broad challenges but now the market is finding specific practical use cases.
“There are great opportunities for DLT to streamline and optimise the movement of collateral obligations so that settlement can be simplified and that will add a lot of benefits for securities finance markets,” he explained.
Taking the concept even further, a third panellist suggested there is a “wider DLT question for capital markets as a whole, which is how do we go to multiple ledgers solving niche problems to full capital market solutions?” This will be the ultimate destination of digitisation, he stated.
The speaker theorised that everything from issuance, to custodian, settlement and financing on a DLT solution could be the answer to a lot of the problems of our market.
Deutsche Boerse’s discussion focused on the development of central counterparties (CCPs) and posed the question: to clear or not to clear? The panellists were unanimous in their answers: maybe.
Elaborating, speakers representing buy and sell-side market participants, explained that when asked whether to clear repo, factors including what type of transaction it is, what side of the street you’re on, whether you’re looking to give or receive cash and, crucially, the market environment and level of volatility at the time all played a part in how to answer the session’s central question.
Taking the past 12 months, panellists noted that the decision to send repos through a CCP has fluctuated in lockstep with the market’s volatility as overall liquidity and the economics of bilateral versus cleared trading shifted.
The growing volume of transactions put through CCPs such as Eurex has been a clear trend in recent years but the volatility seen in 2020 and particularly March and April offered an ideal case study for when the costs of a clearinghouse are worth it for netting efficiencies and security.
Eurex Repo saw term-adjusted volumes jump 10 per cent year-on-year in 2020, including a 39 per cent and 29 per cent YoY increase in GC Pooling and Repo markets in March, respectively.
The panel agreed that the benefits of clearing during market stresses are solid, but whether clearing repo will break out of the ‘use in case of emergency’ mould and build a use case for day-to-day activity was a key area of debate.
Setting the scene, the panel moderator acknowledged the modest but steady growth in cleared repo among the largest sell-side institutions in the US but went on to probe panellists on why the uptake for sponsored repo by buy-side members has not seen a significant uptake so far.
There is roughly $5 trillion in US treasury repo outstanding at any given time. In comparison, only $300 billion is cleared through sponsored repo, Inglis highlighted.
In response, sell-side panellists emphasised that sponsored repo was only one piece of the total repo market and has evolved in recent years.
In 2018, the panellist conceded, the Fixed Income Clearing Corporation’s (FICC) US treasury repo clearing programme had limited activity. Since then the volume has grown between 10-15-fold due to key changes to the model, including expanding the membership.
The joining criteria for sponsored members and sponsoring members now includes all qualified institutional buyers instead of only registered investment companies. Expanded requirements for sponsoring members means the broker-dealer community have joined well-capitalised custody banks. Additionally, FICC adapted the programme from overnight to term and made it a two-way flow to allow repo and reverse repo.
According to a fellow sell-side panellist, this has led to more than 20 members providing sponsors today, up from only three in 2018.
The first speaker explained further how although the average notional volume might be $300 billion, during the COVID-19 volatility period in March and April 2020, the volume hit a high of $550 billion.
“Central clearing is in the toolkit to be utilised when needed,” they explained. “When there was volatility in the market and a need for capacity you saw people accessing this programme.”
The speaker added: “Buy-side clearing doesn’t seem like it’s at critical mass at this point but if you look at the evolution over the past couple of years you’re seeing an increase which points to the fact this is becoming a tool both sell and buy-side are using to create efficiencies and for safety.”
Reviewing the past year, another speaker reinforced the point that the market environment will impact the economics of cleared repo and will therefore drive demand.
“If you can buy treasury bills that offer higher yield than repo then you will. But we are now seeing repo start to overtake bills so we will see the market revert back,” he explains.
However, a panellist representing a buy-side firm that does not clear repo offered a different perspective.
According to the speaker, their firm’s abstention from clearing repo is due in part to the different economics depending on whether you’re a cash giver or taker. The concept of clearing was created when cash was king, which is no longer the case.
“No one wants cash, it’s persona non grata, you can’t place it anywhere which is why money market and treasury funds are being pushed into clearing to gain access to counterparts,” the speaker explained. “I’m sitting on the other side of that and paying for that leverage which is extremely cheap and available today, which you can see from the crunch that didn’t happen at the end of 2020.”
For as long as cash is so accessible it will be cheaper and easier to trade bilaterally, the speaker stated, but went on to acknowledge a future scenario where central bank cash is less available than today and her counterparts reduce their balance sheet availability, inverting the market dynamic.
“The economics must be considered on a case-by-case basis and I will only ever see clearing as part of my toolkit and not my defined route of trading,” the panellist concluded.
Turning to the equity market, the moderator noted Eurex is building out its capabilities in this area, as is the Depository Trust and Clearing Corporation, and invited panellists to offer predictions of whether clearing of equities can match the growth in fixed income.
A speaker representing a major US bank said what he sees in the fixed income space makes him hopeful for equities, both in securities lending and repo products, as he believes in the merits. However, he also echoed the reservations, stating that the cost-benefit analysis for clearing equities is still not good enough for many of his clients.
“Those costs and the model are proving to be challenging right now. We are working through those but fundamentally that’s a challenge,” he said.
In addition, the panellist admitted to being worried that the journey to CCP adoption is still suboptimal in most cases.
“If I look at the hundreds of clients in my bank’s agency lending programme and lay at their doorstep a stack of lending agreements, some will be comfortable with them but not all will be,” he said. “To gain further adoption we need to ease the on-boarding process. We are working on it but it is still early days in this process.”
Looking ahead, when questioned on where the clearing space may be in five years time, the buy-side panellist said she’s confident derivatives, particularly those that contribute to gross notional for regulations such as the Uncleared Margin Rules, will increasingly be put through a CCP.
“It gives you the benefit of liquidity and access, as well as reducing the need to post initial margin bilaterally, which is pretty painful,” they said. “But, on the repo side I don’t think we are there and there’s a further evolution of the model that needs to happen for it to be one everyone can have access to.”
A fourth speaker representing an asset manager that is currently onboarding with Eurex is more bullish. He explains, as a cash giver, that clearing short-dated repo is expected to be a structural part of how the firm runs its cash portfolio. More generally, the speaker said cleared volumes will benefit from increased standardisation in the market, such as with collateral baskets. Like the other panellists, the buy-side speaker implored CCPs to put every effort into minimising the paperwork needed to onboard and said streamlining this process will likely contribute to a volume uptick.
Apart from the CCPs themselves, panellists cited regulators and incoming regulation as additional drivers of clearing adoption. When describing the rush to FICC’s repo programme in 2020, a sell-side speaker said that “during that volatility regulators want to ensure there is safety, soundness, liquidity and resilience in the market and utilising the programme resonates on all those points”. The speaker went on to predict that the combination of market pressures and approval of CCP use from regulators will eventually make clearing an everyday tool as opposed to just one used to mitigate heightened volatility.
Reinforcing this, the second sell-side speaker added that regulations including Basel IV, which has implications for the risk weighting of counterparts, will make trading through a CCP more attractive.
To clear or not to clear is, it seems, a perennial question both within firms and across the securities finance market that must be asked repeatedly and often. Whether it’s driven by a need for liquidity, resilience, regulation, balance sheet efficiency, or all of the above, every time it is posed more of the industry appears to have made a clearinghouse a home.
Panel two: Repo and securities lending: what to expect
Any prediction about what to expect in the year ahead must be made in the context of the year just gone, panellists agreed. The pandemic brought severe volatility to equity markets and a decade of post-crisis regulation to the ultimate test.
As the dust settles and the world appears to be heading towards a post-COVID environment, securities finance market participants are now able to assess the lessons of 2020 and take stock of whether their technology and innovation strategies are still optimal.
Reviewing the fallout of the March-and-April volatility, the panel moderator questioned whether the securities finance market is mispricing risks.
A panellist suggested that 2020 changed the risk landscape by ratcheting up many new factors in addition to the normal financial risks, including several non-traditional exposures such as reputational risk and legal risk.
The major differences between the 2020 volatility and previous crises is that the financial risks going into March were low as banks generally had stronger balance sheets than years gone. Additionally, the market shock was caused by a healthcare issue, not a financial one, which has in part allowed for a rapid recovery only months after the initial shock.
Compared to the 2008 financial crisis, or even in September 2019 when the repo markets had a wobble, last year market overseers were quick to mitigate liquidity issues to such a degree that a panellist questioned whether repo markets are “too comfortable” due to implicit backstops.
An abundance of cash in the market naturally drives a hunt for yield, the speaker said and warned that too much of this trend could create a race to the bottom, which must be avoided.
“It’s important to still apply fundamental risk metrics, examining counterparties, asset mixes and adjusting and reconfirming views frequently,” they stated.
Another panellist added: “The industry’s risk management skills were put to the test in 2020.”
Liquidity risk emphasised by the spike in margin calls hammered home the importance of repo and secured financing markets which are intertwined with collateral and derivatives markets, he argued.
Secondly, settlement frictions also became apparent, noting “we have this global infrastructure which works fine during normal times but when we hit these periods of stress it really does start to creak”.
“We need to look for solutions that enable us to move collateral and liquidity around the globe during all the currency timezones and jurisdictions,” the speaker mused.
Thirdly, the panellist highlighted counterparty risk while acknowledging that the market appeared to be mobilising to prevent defaults by assisting in meeting margin calls, a very different reaction to previous crises when haircuts increased sharply and ensured troubled entities were drowned in capital demands.
“We are not even 12 months past the volatility last year and haircuts are around the lowest they’ve ever been while spreads are also very low so we need to watch that stretch on risk and reward,” he concluded.
The moderator followed this by asking if these concerns amounted to an argument for minimum haircuts. The speaker responded that the Financial Stability Board has done a lot of research into this question and minimum haircuts might help but went on to argue more emphasis should be placed on the models for making sure market participants are “thinking very carefully about the risks they are taking”.
Turning to the future and comparing US and EU repo markets, an EU-based speaker predicted that changes to balance sheet reporting and leverage ratio calculations under Basel III will impact the market landscape.
From March, US banks will begin applying capital charges and will be required to report a daily snapshot of their balance sheet as opposed to a quarterly report, with European banks applying a similar system from January 2022.
“There’s no doubt that because European banks have so far been managing their balance sheets on quarter-end this will reduce the amount of balance sheet available for clients,” he said.
The speaker noted that US rule changes contributed to an increase in sponsored repo volume and suggests the same may occur in Europe.
“The new rules are a good development that will help market stability enormously,” added a panellist. “Some of the temporary leverage ratio exemptions have added capacity for banks to provide liquidity and it’s really important that they aren’t constrained from providing liquidity against high-quality liquid assets from a risk-weighted asset perspective.”
However, he noted, moving liquidity away from banks and into a direct clearing system only shifts the problem. Banks need to be allowed to lend responsibly as that’s the only way the market can wean itself off the central banks, he affirmed.
The European panellist concurred and argued that the financial market community should not give up the fight in lobbying for government bonds to be permanently excluded from the leverage ratio “to keep the stability and good functioning of the markets”.
The future is digital
According to a different panellist, the future is digital, but foundations for widespread adoption are not yet firmly established.
The standardisation of data, legal hurdles and the technology infrastructure that surrounds it are all areas that must be addressed before widespread adoption can be achieved, he said.
The implementation of the Securities Financing Transactions Regulation revealed “an industry-wide failure” as firms tried to communicate with each other with “wobbly standards” that prevented them from effectively sharing information both externally and internally.
A lack of standardisation with credit ratings, ISINs and legal entity identifiers (LEI) is undermining efforts to allow for the free-flow of data, he explained.
Preliminary data from a market survey by several trade bodies, including the International Securities Lending Association (ISLA), indicates that there are more than 49,000 securities within the securities finance ecosystem that were reported to have a variety of LEI issues.
The speaker emphasised the conclusion first made at the 2020 Securities Finance Times Technology Symposium that the CDM and blockchain are “a match made in heaven” but reiterated that the foundations of good data husbandry must be in place first.
“By the end of this year, once these blocks are in place, both ISLA and the International Capital Market Association will be in a position to have something that firms can start adopting,” the panellist said. “This time next year we will have a much clearer view about what the impact of these initiatives will be.”
A separate speaker reinforced this point, noting that when distributed ledger technology (DLT) was first introduced it was touted as a grand solution to very broad challenges but now the market is finding specific practical use cases.
“There are great opportunities for DLT to streamline and optimise the movement of collateral obligations so that settlement can be simplified and that will add a lot of benefits for securities finance markets,” he explained.
Taking the concept even further, a third panellist suggested there is a “wider DLT question for capital markets as a whole, which is how do we go to multiple ledgers solving niche problems to full capital market solutions?” This will be the ultimate destination of digitisation, he stated.
The speaker theorised that everything from issuance, to custodian, settlement and financing on a DLT solution could be the answer to a lot of the problems of our market.
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