The mobilisation of collateral in Europe could be severely hindered by derivatives market Eurex’s desire to maintain its monopoly in trading and clearing certain baskets of tri-party repo instruments.
The instruments in question – GC Pooling baskets – contain tri-party repo instruments including various high-quality fixed income products, like sovereign bonds, and are used by banks to switch these assets into cash and vice versa.
The basket is a popular and efficient tool that will allow banks to easily access cash, which will be an important source of collateral underpinning OTC derivatives transactions that will soon be centrally cleared under the European market infrastructure regulation (EMIR).
Under the incoming rules buy-side firms will be required to post initial and variation margin – the latter of which can only be paid in cash – against their swaps exposures. Investment institutions will look to clearing brokers to meet margin requirements on their behalf, which necessitates smooth transfer of collateral.
GC Pooling baskets are currently traded and cleared through Eurex but only the assets held by Clearstream, the international central securities depository (ICSD) owned by Eurex’s parent firm Deutsche Börse Group, can be used for these transactions.
Although a link between Clearstream and rival ICSD Euroclear does exist, costly enhancements will be needed to facilitate GC Pooling basket trades. While Eurex initially appeared willing to invest in these developments, progress looks to have stalled.
At a recent meeting between the European Repo Council (ERC) and the European Association of Clearing Houses (EACH), Eurex indicated it sees no business case in further developing the ICSD connection.
“This move by EACH, which represents several fixed income CCPs in Europe, is counterproductive and goes against the regulatory aims of OTC derivatives reform,” said Godfried De Vidts, chair of the International Capital Market Association’s European Repo Committee. “ICSD interoperability in tri-party will enable cash and bonds to flow through the system very easily and the ERC has pushed for this for many years. The reluctance by EACH members to facilitate access by the community to a wider range of collateral is a real pity for the market.”
A link between Clearstream and Euroclear would allow collateral held by banks in either ICSD to be used for GC Pooling basket trades. But fully connecting the two entities is likely to be a complex task given the separate systems and protocols used by each. Banks that are already engaged in costly post-trade connectivity projects ahead of the new swaps rules have indicated that they would be unwilling to fund a link themselves.
According to Marcus Zickwolff, chairman of EACH and head of trading and clearing systems design at Eurex, the CCPs have declared their willingness to assess the implementation of such a solution.
“The debate is now centred on technicalities,” said Zickwolff, referring to difficulties in enhancing the Euroclear-Clearstream link related to the timing of collateral delivery. “However CCPs need to take care of financing the project and can only implement solutions, which are commercially useful for all involved parties.”