The European roadmap
20 February 2024
Cyril Louchtchay de Fleurian examines a roadmap for growth and efficiency gains in European repo markets, including a case for the repositioning of GC Pooling and €GCplus solutions
Image: stock.adobe/happyvector071
The first contribution to this three-part article, published in Securities Finance Times Issue 345, examined synergies in clearing and triparty repo. This, the second part, looks more closely at the ecosystem supporting use of general collateral baskets in Europe and potential designs for repositioning GC Pooling and €GCplus.
The micro-economic and technical analysis of the GC Pooling and €GCplus pair partially explains some current pitfalls. It is a key preamble — necessary but not sufficient — towards outlining solutions aimed at increasing volumes towards the potential target of €500 billion.
In addition to this first aspect, it is necessary to zoom out our analysis and explain why the evolution of these GC offers is important. What problem are we trying to solve by repositioning GC Pooling and €GCplus? Why should we collectively invest to do so?
To answer this question, we have identified two fundamental issues that crystallise this problem and in which GC Pooling and €GCplus can play an instrumental role. The first concerns the decline in the velocity of collateral circulation. The second relates to the shift in bias on liquidity conditions, necessitating a change in the temporality of monetary operations. These are systemic issues and are likely to be subject to close scrutiny from central bankers.
In these circumstances, it becomes necessary to stimulate collateral velocity and related liquidity to minimise systemic risks. To achieve this result, it is first necessary to broaden the base of flows and concentrate them — to increase the execution speed and rotation of collateral, notably by changing the temporality of certain operations through the introduction of ‘intraday’ transaction management.
Collateral velocity
As an explanation, there is a relatively unknown indicator that collapsed from 3.0 in 2007 to 1.8 in 2016 (-40 per cent), rebounded to 2.3 in 2020, only to decline again to 2.0 in 2022. This indicator has lost more than 30 per cent over 15 years, without making headlines, although it should have.
This indicator is the collateral velocity rate, in other words, its circulation speed. This refers to how frequently collateral is exchanged or used in various transactions — a measure of how quickly it changes hands or is reused in the financial system. Collateral velocity is influenced by factors such as market liquidity, financial institutions' risk management policies, and prevailing regulations. Higher collateral velocity indicates more active use in financial transactions, suggesting more efficient asset utilisation and better allocation.
In the European markets over the past 15 years, collateral velocity has significantly decreased for four main reasons: risk aversion since the 2008-09 financial crisis; balance sheet constraints faced by banks; the expansion of quantitative easing by the central banks; and regulations limiting dealers' intermediation capacity. The direct consequence is a structural limitation of collateral availability, essentially resulting in a net destruction of collateral. Less collateral in the system affects market liquidity and becomes synonymous with increased systemic risks.
In schematic terms, market collateral liquidity depends on two parameters: the stock of mobilisable securities and its rotation speed. Based on a European repo market of €5.4 trillion, if the rotation speed drops from 3.0 (the level in 2007) to 2.0 (the level in 2022), the system mechanically destroys €1.65 trillion of collateral, equivalent to 33 per cent of the European repo market. This is more than 50 per cent of the French debt. This decline is not an epiphenomenon but a structural trend; it is the "drying up" syndrome.
To prevent this inevitable risk, there are several possible approaches. One is to intensify regulatory pressure. Alternatively, the central bank can increase its interventions. Both paths have been utilised extensively in recent years and could be counterproductive today.
More sustainably, collateral velocity can be stimulated by developing interoperability between triparty links to enhance collateral fluidity — this technical bridge in 2024 is called GC Pooling or €GCplus. Since we have the tools, let's seize the opportunity to provide the market with tangible means to structure its self-regulation.
Defragmenting silos
In this context, innovative solutions such as the creation of digital tokens or tokenisation supported by blockchain technology are particularly suitable. The goal is to have easily real-time mobilisable guarantees without friction. Here again, European offerings GC Pooling and €GCplus can serve as ‘standards’ and possess all the necessary qualities to be pioneers. To illustrate my point, exchanging the key to the safe is more effective than its contents — less friction, the same guarantees, better traceability, better dynamics.
However, these solutions should not be considered in isolation but revolve around a technical improvement of the pipes through which collateral circulates. We have already discussed the logic of ‘breaking down walls’, in other words, defragmenting existing silos. In addition to this foundational principle, this evolution involves the digitisation of transaction processes, adopting digital processing platforms, electronic collateral management negotiation systems, and data collection and analysis solutions.
Electronic negotiation improves efficiency, speed and transparency. The automation of operations, settlements and reports reduces dependence on manual entries and, more generally, human interventions. Data collection and analysis involve market data, price information, credit ratings, historical performance and investor preferences, responding to the implementation of more sophisticated and responsive strategies.
Access and connectivity simplify interactions between participants, thereby expanding the market's scale. Finally, risk management monitoring and compliance verification can occur in real-time through enhanced transparency. All these elements, in combination, replace outdated capital with new and technological capital which, by design, will stimulate collateral velocity.
Intraday management
The second risk issue we want to zoom in on relates to aligning market temporality. Behind this obscure term lies a new and systemic issue that brutally manifested itself in the US banking system a few months ago through the failures of Silicon Valley Bank, Signature Bank and First Republic Bank.
In essence, it becomes necessary to align the near-instantaneous ability that individuals and businesses have to manage their cash in their bank accounts with the operations and risk management capabilities that banks possess in the market. Factually, this shift in bias observed in liquidity conditions — facilitated by the digital tools available to economic agents — requires evolving the temporality of monetary operations.
This involves developing the concept of intraday management. In other words, the same-day value date is no longer an impassable horizon but must be restructured around distinct intraday time slots, allowing for processing, settlement and delivery based on specific intra-day time points. It is nothing less than a matter of systemic security.
Exit is the dilution of the same-day value date in a single and homogeneous temporal continuum. Thanks to their specific design (clearing, digital execution, back-office support allowing real-time valuation, substitution and margin calls), GC Pooling and €GCplus are inherently equipped to meet this major challenge. The technological synergies in terms of connectivity, tokenisation and blockchain, along with anticipating defaults through machine learning or artificial intelligence (AI), will enable real-time responses to possible bank runs that jeopardise market integrity. In this space, the connectivity of an HQLA GC basket to the Central Bank Digital Currency (CBDC) remains promising and technically tangible today.
The micro-economic and technical analysis of the GC Pooling and €GCplus pair partially explains some current pitfalls. It is a key preamble — necessary but not sufficient — towards outlining solutions aimed at increasing volumes towards the potential target of €500 billion.
In addition to this first aspect, it is necessary to zoom out our analysis and explain why the evolution of these GC offers is important. What problem are we trying to solve by repositioning GC Pooling and €GCplus? Why should we collectively invest to do so?
To answer this question, we have identified two fundamental issues that crystallise this problem and in which GC Pooling and €GCplus can play an instrumental role. The first concerns the decline in the velocity of collateral circulation. The second relates to the shift in bias on liquidity conditions, necessitating a change in the temporality of monetary operations. These are systemic issues and are likely to be subject to close scrutiny from central bankers.
In these circumstances, it becomes necessary to stimulate collateral velocity and related liquidity to minimise systemic risks. To achieve this result, it is first necessary to broaden the base of flows and concentrate them — to increase the execution speed and rotation of collateral, notably by changing the temporality of certain operations through the introduction of ‘intraday’ transaction management.
Collateral velocity
As an explanation, there is a relatively unknown indicator that collapsed from 3.0 in 2007 to 1.8 in 2016 (-40 per cent), rebounded to 2.3 in 2020, only to decline again to 2.0 in 2022. This indicator has lost more than 30 per cent over 15 years, without making headlines, although it should have.
This indicator is the collateral velocity rate, in other words, its circulation speed. This refers to how frequently collateral is exchanged or used in various transactions — a measure of how quickly it changes hands or is reused in the financial system. Collateral velocity is influenced by factors such as market liquidity, financial institutions' risk management policies, and prevailing regulations. Higher collateral velocity indicates more active use in financial transactions, suggesting more efficient asset utilisation and better allocation.
In the European markets over the past 15 years, collateral velocity has significantly decreased for four main reasons: risk aversion since the 2008-09 financial crisis; balance sheet constraints faced by banks; the expansion of quantitative easing by the central banks; and regulations limiting dealers' intermediation capacity. The direct consequence is a structural limitation of collateral availability, essentially resulting in a net destruction of collateral. Less collateral in the system affects market liquidity and becomes synonymous with increased systemic risks.
In schematic terms, market collateral liquidity depends on two parameters: the stock of mobilisable securities and its rotation speed. Based on a European repo market of €5.4 trillion, if the rotation speed drops from 3.0 (the level in 2007) to 2.0 (the level in 2022), the system mechanically destroys €1.65 trillion of collateral, equivalent to 33 per cent of the European repo market. This is more than 50 per cent of the French debt. This decline is not an epiphenomenon but a structural trend; it is the "drying up" syndrome.
To prevent this inevitable risk, there are several possible approaches. One is to intensify regulatory pressure. Alternatively, the central bank can increase its interventions. Both paths have been utilised extensively in recent years and could be counterproductive today.
More sustainably, collateral velocity can be stimulated by developing interoperability between triparty links to enhance collateral fluidity — this technical bridge in 2024 is called GC Pooling or €GCplus. Since we have the tools, let's seize the opportunity to provide the market with tangible means to structure its self-regulation.
Defragmenting silos
In this context, innovative solutions such as the creation of digital tokens or tokenisation supported by blockchain technology are particularly suitable. The goal is to have easily real-time mobilisable guarantees without friction. Here again, European offerings GC Pooling and €GCplus can serve as ‘standards’ and possess all the necessary qualities to be pioneers. To illustrate my point, exchanging the key to the safe is more effective than its contents — less friction, the same guarantees, better traceability, better dynamics.
However, these solutions should not be considered in isolation but revolve around a technical improvement of the pipes through which collateral circulates. We have already discussed the logic of ‘breaking down walls’, in other words, defragmenting existing silos. In addition to this foundational principle, this evolution involves the digitisation of transaction processes, adopting digital processing platforms, electronic collateral management negotiation systems, and data collection and analysis solutions.
Electronic negotiation improves efficiency, speed and transparency. The automation of operations, settlements and reports reduces dependence on manual entries and, more generally, human interventions. Data collection and analysis involve market data, price information, credit ratings, historical performance and investor preferences, responding to the implementation of more sophisticated and responsive strategies.
Access and connectivity simplify interactions between participants, thereby expanding the market's scale. Finally, risk management monitoring and compliance verification can occur in real-time through enhanced transparency. All these elements, in combination, replace outdated capital with new and technological capital which, by design, will stimulate collateral velocity.
Intraday management
The second risk issue we want to zoom in on relates to aligning market temporality. Behind this obscure term lies a new and systemic issue that brutally manifested itself in the US banking system a few months ago through the failures of Silicon Valley Bank, Signature Bank and First Republic Bank.
In essence, it becomes necessary to align the near-instantaneous ability that individuals and businesses have to manage their cash in their bank accounts with the operations and risk management capabilities that banks possess in the market. Factually, this shift in bias observed in liquidity conditions — facilitated by the digital tools available to economic agents — requires evolving the temporality of monetary operations.
This involves developing the concept of intraday management. In other words, the same-day value date is no longer an impassable horizon but must be restructured around distinct intraday time slots, allowing for processing, settlement and delivery based on specific intra-day time points. It is nothing less than a matter of systemic security.
Exit is the dilution of the same-day value date in a single and homogeneous temporal continuum. Thanks to their specific design (clearing, digital execution, back-office support allowing real-time valuation, substitution and margin calls), GC Pooling and €GCplus are inherently equipped to meet this major challenge. The technological synergies in terms of connectivity, tokenisation and blockchain, along with anticipating defaults through machine learning or artificial intelligence (AI), will enable real-time responses to possible bank runs that jeopardise market integrity. In this space, the connectivity of an HQLA GC basket to the Central Bank Digital Currency (CBDC) remains promising and technically tangible today.
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