Central Clearing of Repos in Australia: A Consultation Paper March 2015 1. Introduction
Repurchase agreements (repos) are one of the most common forms of collateralised financing in wholesale markets and play an important role in financial institutions' funding and liquidity management activities. Under a repo contract, one party sells a security to another at a price today, committing to repurchase that security at a specified future price and date; the difference between these two purchase prices reflects the interest rate paid by the securities provider.
Given its centrality and importance, it is crucial that the market for repos functions continuously and effectively, even in stressed circumstances. Consistent with developments in other core markets, such as that for over-the-counter (OTC) interest rate derivatives, central counterparty (CCP) clearing could improve market functioning and reduce systemic risk by enhancing risk and default management, increasing transparency and providing operational efficiencies. Recently, as part of a broader workstream on repos and securities lending, the Financial Stability Board (FSB) recommended that:
Authorities should evaluate, with a view to mitigating systemic risks, the costs and benefits of proposals to introduce CCPs in their inter-dealer repo markets where CCPs do not exist. Where CCPs exist, authorities should consider the pros and cons of broadening participation, in particular of important funding providers in the repo market.[1]
Currently, no CCP clears transactions in the Australian repo market. Therefore, consistent with this recommendation, Australian authorities have begun work to evaluate the costs and benefits of central clearing of repos in Australia. This work is being led by the Reserve Bank. To support this evaluation, this consultation paper invites stakeholder views on how the design and operation of a repo CCP might affect the functioning of the Australian repo market and the management of risk, in both normal and stressed market conditions.
1.1 Background on Repo Clearing in Australia
While there is currently no repo CCP operating in Australia, there is some precedent for such arrangements. In the early 2000s, ASX Clear (Futures) – at that time known as SFE Clearing Corporation (SFECC) – operated a Bond and Repo Clearing (BRC) service. At that time, around 40 per cent of fixed income securities transactions were cleared through the BRC service.
However, a number of market participants did not use the service. This led to some difficulties in concluding the delivery-versus-payment (DvP) settlement of chains of transactions, where some parties in the chain were using the BRC service and others continued to clear bilaterally. To conclude a chain of settlements, one of the participants had to obtain the security to meet its delivery obligation. This was sometimes difficult due to the low level of Commonwealth Government securities (CGS) on issue at the time. Ultimately, these issues reduced the attractiveness of the BRC service, and use declined until the service was suspended in July 2004.
With settlement practices in the fixed income market having evolved over the past decade, and CGS issuance having increased significantly, settlement issues arising from chains of trades are uncommon. Furthermore, securities can now be more easily obtained, including from the Stock Lending Facility offered by the Australian Office of Financial Management (AOFM). Consequently, settlement may be less of a concern for any future repo CCP, even if some participants do not centrally clear their repos.
1.2 Issues for Consultation
The overarching question that the Bank is seeking to answer through this consultation process is whether the capacity of the Australian repo market to safely, efficiently and continuously support the funding and liquidity needs of the Australian financial system would be improved by the availability of a repo CCP.
In making its recommendation, the FSB noted that there was significant potential for central clearing to reduce the size of credit exposures through multilateral netting as dealers often had offsetting trades with each other. Other system-wide and stability benefits from CCP clearing may arise from enhanced risk management of repos in normal conditions – including settlement of net gains and losses at least daily, and more frequently in periods of market volatility – and coordinated management of any participant default. Given their central role, CCPs can also drive operational improvements and efficiencies in a market. In other jurisdictions, ensuring the continued functioning of the repo market during a period of instability, or when there are perceived counterparty credit issues, has also been a particular motivating factor in encouraging central clearing of repos.
In its work, the FSB concluded that for interdealer repos against high-quality, liquid collateral ‘existing incentives to use CCPs in these markets seem sufficiently strong (e.g. balance sheet netting) and no further regulatory or other actions appear necessary’. Consistent with this view, if the Bank concluded that there was a net benefit to there being a repo CCP in Australia, it is likely that the Bank would rely on a provider's commercial incentive to introduce such a service, and market participants' private incentives to make use of the service.
A key issue in the consultation will therefore be whether market participants would indeed use a repo CCP if such a service became available in the Australian market. This will depend on each participant's evaluation of the private benefits and costs. In particular, it will depend on each participant's assessment of the scope to reduce its credit exposures in interdealer repos through multilateral netting, and thereby realise both collateral and regulatory capital benefits. Since not all repo market participants may choose to, or be eligible to, centrally clear, the implications for the participation structure of the repo market will need to be considered carefully.
These issues are considered further in the remainder of this consultation paper, which is set out in three main sections:
- The Australian Repo Market. This section provides an overview of the Australian repo market, describing the nature and scale of current activity in the market and prevailing operational and risk management practices. The section closes with a short review of the BRC service.
- Key Features of Repo CCPs. This section first introduces the role of a CCP and the potential costs and benefits of central clearing. It goes on to consider the particular implications of CCP clearing in the Australian repo market. The main focus is on how counterparty credit risk management might change, and how central clearing could encourage new operational efficiencies. Implications for settlement arrangements are also considered. Finally, the section provides an overview of the design of existing repo CCPs internationally.
- Costs and Benefits of a Repo CCP – Issues for Consultation. Drawing on the observations in the preceding sections, the paper closes with an overview of the key issues on which stakeholder feedback is sought to assist in evaluating the costs and benefits of central clearing in the Australian repo market.
While the primary focus of this consultation is the repo market, which is consistent with the scope of the FSB's recommendation, many existing repo CCPs internationally also clear outright purchases and sales of bonds. Accordingly, consultation respondents are also invited to offer views on the desirable product scope of any future repo CCP in Australia.
1.3 Next Steps
The Bank has issued this consultation paper to encourage all interested stakeholders to engage in a thorough discussion about the costs and benefits of central clearing of interdealer repo transactions in Australia. The Bank recognises that stakeholders' interests will not necessarily be aligned and also acknowledges the uncertainty arising from the absence of a concrete proposal that sets out the key design features of such a CCP and the potential scope of participation. The Bank also recognises that, since it is counterparty to around a third of the value of repos currently outstanding, its decision regarding participation will affect other market participants' evaluation of the private costs and benefits of using a repo clearing service. The Bank will consider its position in light of stakeholder feedback from this consultation.
The Bank welcomes comments on any matters discussed in this paper. As a basis for discussion, a number of questions have been suggested in Section 4, to which stakeholders might wish to respond.
Written submissions are welcome. All submissions and correspondence received (including any contact names or other personal information) will be made public on the Bank's website, unless it is specifically requested that the Bank treat the whole or any part of a submission as confidential. For further information about the Bank's collection of personal information and approach to privacy, please refer to the Personal Information Collection Notice for Website Visitors and the Bank's Privacy Policy, which are both available at <http://www.rba.gov.au/privacy/>.
The Bank requests that formal submissions and comments in response to this consultation paper be received by 17 April 2015. Please direct all correspondence and other requests to
| Email: | RepoCCPConsultation@rba.gov.au |
| Address: | Repo Central Clearing Consultation GPO Box 3947 Sydney NSW 2001 Australia |
The Bank will separately hold discussions with relevant Australian Financial Markets Association (AFMA) committees in the period ahead, and will arrange bilateral meetings with AFMA members and other stakeholders on request.
Footnote
FSB (2013), ‘Strengthening Oversight and Regulation of Shadow Banking: Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos’, August. Available at <http://www.financialstabilityboard.org/publications/r_130829b.pdf>. [1]