Cleared Term DBV
23 July 2013
Key dates
• February 2014:
– Market testing on an end-to-end LCH.Clearnet/CREST test platform
• March 17 2014:
– Euroclear UK & Ireland launch underpinning settlement changes to
the CREST system.
• April 2014:
– LCH.Clearnet launch their new Term £GC service and start the
transition from the current Sterling GC service.
AGENDA
1.
Term DBV: a perspective from the Bank’s front office
– Andrew Hauser: Head of Sterling Markets Division
2.
The case for change
– Toby Davies: Head of Market Services Division
3.
Key features of the new Cleared Term DBV service
– CREST system enhancements: David Nicholas, Euroclear UK & Ireland.
– New Term £GC product: Nigel Bradley, LCH.Clearnet.
4.
Sub-group update, and member actions required
– Ian Fox: Chair, MMLG sub-group for Cleared Term DBV.
5.
Q&A (Panel session)
6.
Closing remarks
– Ian Mair: Chair, London Money Market Association
Cleared Term DBV
23 July 2013
Term DBV: a perspective from
the Bank’s front office
Andrew Hauser
Head, Sterling Markets Division
Chair of Money Market Liaison Group
Chair of Securities Lending and Repo Committee
From small acorns...
...secured flows now dwarf unsecured
Average daily turnover in sterling money market (Nov 2012)
Aggregate
£ billions
120
Interbank
100
80
60
40
20
0
Unsecured
Secured
Gradual shift to secured: a global trend
Secured transactions as share of total turnover
Improving market resilience
•
Repo reduces (though not eliminates!) counterparty risk
• But highly collateralised world increases macroprudential
risks – some of which crystallised during the financial crisis
•
Global response overseen by Financial Stability Board:
• Main focus on ‘procyclicality’
• But mitigating operational risk also important
• UK challenges not on same scale as eg US triparty - but
mismatch between daily DBV settlement unwind and term of
underlying deals does pose operational and liquidity risks
Term DBV volumes: the only way is up!
£ billions
200
180
Value of overnight DBV settled
(not counting unwinds)
160
140
120
100
80
60
40
Value of open Term DBV
20
0
Oct
2011
Jan
2012
Apr
Jul
Oct
Jan
2013
Apr
The Bank’s front office interests
• Broad interest in stability of the market: key
transmission channel for monetary policy
• DBV central to Bank’s own operations:
– Peak daily value during crisis = £85bn
– From July 2011, Bank counterparties have had
option of using Term DBV in OMOs and OSFs...
– ...and we made it clear that we were ‘minded to
discontinue use of Rolling Overnight DBV’
• MMLG oversight
“The system may be safer, but what’s in it
for me?”
• Safer system benefits everyone, but also...
– Settlement costs and exposures
(Toby Davies will cover)
– Margin costs (LCH.Clearnet will cover)
“The system may be safer, but what’s in it
for me?”
• Safer system benefits everyone, but also...
– Settlement costs and exposures
(Toby Davies will cover)
– Margin costs (LCH.Clearnet will cover)
Front office engagement crucial to success of
the exercise
– Good practice guidelines (Toby/Ian will cover)
Cleared Term DBV
23 July 2013
The case for change
Toby Davies
Head of Market Services Division
23 July 2013
Current DBV mechanism
• Current overnight DBV model is tried-and-tested
o low cost easy way of delivering market-defined baskets of GC
o no substitutions or mark-to-market needed because collateral is
returned every morning
o reliable
• But it masks hidden issues
o an inefficient and risky churn of daily return and reissue
o dependency on provision of central bank liquidity through auto
collateralised repo to fund intraday positions
Risks
• In the event of a counterparty or system-wide outage intraday
between morning unwind and afternoon re-input:
o DBV counterparties would be left holding the ‘wrong’ asset
o counterparties would be required to manage liquidity dislocation
DBV counterparties and their CREST settlement banks would be left
with credit exposures
o the Bank would be left with intra-day liquidity extension to settlement
banks that might need to be converted into overnight facilities
o The values are substantial
11 November 2011
• Severe SWIFT outage on 11 November 2011 meant many of the
day’s DBVs (including LCH’s) could not be submitted until very
late in the day
• DBV value input after the outage was resolved was £159bn
• Outstanding IDL (a large proportion of which is normally repaid
automatically in afternoon DBVs) was at £82bn at the point of
failure
The challenge
• The Bank has been exercised by the risks for many years
• Objective is to align the settlement arrangements with the
underlying economic terms of the repo
o not to change the fundamental form of the trade
• The challenge is to reduce risks while retaining the benefits of
the DBV basket collateral mechanism.
• The introduction of Term DBV within CREST in 2011 provided an
underlying mechanism
o but could not gain sufficient traction without being cleared through
LCH.C which accounts for ~40% of DBV value settled.
Benefits
• From reduction in daily cash and collateral settlement flow
o in aggregate, less credit needed for settlement
o reduced position management ahead of DBV settlement window
o reduced reliance on central bank liquidity provision
o Tail risk
o reduced risk from operational interruption
o only overnight and new business exposed to intraday interruption
o reduced potential dislocation of liquidity
Good market practice is essential
• collateral giver
o to maintain pool of eligible collateral to feed mark-to-market and
substitutions
• collateral taker
o to ensure substitutions do not fail by keeping received collateral
available for substitution and return
o CREST is able to manage substitutions because it recognises a
closed loop of collateral given/received in DBV. This breaks down if
you deliver away received stock other than as DBV.
o Two approaches:
o Hold stock in segregated account
o Careful position management
Summary
• Focus today is LCH introduction of a cleared Term GC product.
• The issue is to align the settlement process with the economic
terms of the repo
o without fundamentally changing the latter
• The objective is to reduce potentially significant risk in the event
of a counterparty or system-wide outage that prevents DBV
settlement
• The change will need to be carefully coordinated.
Cleared Term DBV
23 July 2013
Clearing Term DBV
Bank of England Seminar
23 July 2013
26
Functional Overview
•Input and selection
Uses existing DBV algorithm (basket based and size first)
►Return date (1 day – 2 years)
►Settling between 3:00pm and 4:10pm
►
•Mark to Market
Overnight: identifies DBVs that are incorrectly collateralised
(based on closing price)
►Intraday: Generates transaction to rebalance collateral levels to
cover cash value of transaction
►Generated (in full or partial) if stock is available
►Links across multiple transaction legs (even where position is flat)
►
27
Functional Overview
•Substitutions (Eligibility & Giver Recall)
Automatic recall based on Corporate Action or settlement need
►Delivery versus delivery
►Runs throughout the day to support settlement fails
►Recall/substitution possible over a wide chain/array of
transactions
►
•Adjustments
Ability to adjust the value of collateral sought, consideration or
length of term during the term of the DBV
►
•Interest Calculation
Interest accrued daily for length of term (TDI)
►
28
Recall Substitution
•Simple Substitution (Bilateral model)
•Day 1: delivers £100m DBV (UBG) 7 day term
Party A
£100m Gilt 3
DBV £100m UBG
7 day term
Party B
£50m Gilt 1
£50m Gilt 2
•Day 2: Party A delivers £25m gilt 1 to Party C
Party A
Sub (TDG) £25m Gilt 3
Party B
Sub (TDG) £25m Gilt 1
£25m Gilt 1
£50m Gilt 2
£25m Gilt 3
£75m Gilt 3
DEL £25m
Gilt 1
Party C
29
Recall Substitution
•Complex Substitution
CCP is less vulnerable to subs fails given the large number of
counterparty holdings
►
TDG £5m Gilt 2
Mbr X
Mbr F
Mbr A
TDG £5m Gilt 1
Mbr B
Mbr C
Mbr H
Mbr G
LCH
Mbr H
Mbr D
Mbr I
Mbr E
30
Cleared Term DBV Enhancements
•Direct input of Term DBVs and Term DBV Adjustments from
LCH.C
•Support settlement of Giver Recall Substitutions, Term DBV
Maturity Returns and Own Account Transfers alongside DBV
settlement in order to satisfy settlement efficiency/minimise
fails
•Support early closing of a open term DBV via LCH
•Substitutions triggered by Term DBV Amendment (during
DBV settlement)
•Removal of diary time slicing (full availability of substitutions)
•Support of negative interest rates
31
Market Practice
•Successful operation of substitution functionality –
dependant on collateral being maintained within collateral
arrangements (no onward Delivery of Collateral other than
by Term DBV)
•Substitution not possible where collateral moved outside
collateral arrangements
•No enforcement tools
No Settlement Discipline regime
►Requires adherence to good market practice
►
•Options to avoid unintentional delivery of collateral outside
of collateral arrangements:
Account Segregation - Main Trading and Collateral Accounts
►Single Account – inventory management challenge
►
32
Account Segregation
•DBVs ‘Collateral Account’ separate from Main Trading
Account
•Advantages:
no possibility of unintentional delivery of collateral outside of
collateral arrangements
►Clear view of Available Balance (securities available to
trade/deliver)
►
•Disadvantages
Account rebalancing necessary (top up/draw downs)
►
–Own
Account Transfers in DBV settlement window
–Movements in individual lines of securities
33
Single Account
•Single account for all activity (DBVs and Main Trading
Account)
•Advantages:
Maximum flexibility
►
•Disadvantages
Requires accurate management of positions
►
–Clear
view of what is held as collateral
–What is available for delivery
•To support a single account:
Addition of ‘non Collateral Balance’ to CREST GUI and FT DEX
messages (derived) – visibility of unencumbered balance
►
–Available
Balance – Collateral Balances
34
DBV Reporting Tools
•To support the market:
•Report per participant
Highlighting any inadvertent breaches of good practice
►Nil Return Report – confirming non-breaches
►
•Monthly summary reports
No participant details
►Persistent breaches – highlighted to participants individually
►
35
Testing Availability
•Test Environment available for testing Term DBV
functionality
•Block Booking – Nov/Dec 2013
•No charge for testing during this period
36
37
Cleared Term DBV
23 July 2013
Term £GC
Product Overview
Bank of England
23 July 2013
Term £GC Overview
Term £GC
Trading
GB00BC7H8L40
Sterling
GC
GB00B1347K44
Features of cleared product
Term £GC
Product Definition
Sterling GC
Product Definition
Settlement mechanism
TDBV Settlement
DBV Settlement
Term £GC Key Benefits
•
Reduced operational risk and settlement credit needs due to the elimination of the requirement for
daily return of cash and collateral compared to the current Sterling GC product.
•
Introduction of margin offsets between trades relating to specific bonds e.g. the existing cleared Gilts
market, and allocations resulting from Term £GC trades.
40
Term £GC Overview
• Sterling denominated repo trades based on the CREST Unstripped British Government (“UBG”)
Delivery by Value (“DBV”) class.
•
Term £GC will be made available for trading via electronic trading platforms and anonymous trading
will be available.
•
Bilateral and voice brokered trades will also be supported.
•
Overnight trades and term trades (up to 374 day term) accepted.
•
Settlement, using Euroclear UK & Ireland’s (“EUI”) Term DBV (“TDBV”) settlement platform, is
instructed by RepoClear and automatically matched via the Direct Input facility.
•
Collateral allocated as part of a Term £GC trade can be substituted in the same manner as any
other collateral utilised within the TDBV environment.
•
Participants’ positions will be maintained in CREST utilising standard Mark to Market functionality
augmented with LCH.Clearnet Risk management processes.
41
Term £GC – Trading, Clearing and Settlement
RepoClear Participant
Trade
Acceptance
Message
Execute
Term £GC
Trade
Netting &
Shaping
Reports
Margin
Reports
Manage
collateral
allocations,
substitutions
and returns
Electronic
Trading
Platforms
Risk Management
Te
r
m
Match
Trade
Voice
Brokers
(via ETCMS)
Trade &
Position
Reports
ad
£GC tr
Term
£G
C
e
tra
TDBV Instructions
de
Settlement
Netting
Trade
Registration
CREST
st
Intere
Repo tion
c
Instru
Allocation
informaton
LCH.Clearnet
42
Manage
Funding
Trade Registration
•
Trade registration supported from 07.00 to 18.00 (all times are London time)
•
Cut off for registration of trades for same day settlement: 14.30
•
Fixed term trades
•
Fixed repo rate (positive, negative or zero)
•
Cash fill basis (defined in GBP)
•
Based on EUI’s definition of Unstripped British Gilt (“UBG”) class
• Consistent with Sterling GC
• LCH.Clearnet retains ability to exclude specific ISINs
•
Overnight to 374 day terms will be supported
•
Forward start periods of up to 374 days
43
Risk Management
Initial Margin
• Term £GC trades will be margined both intra-day and at end of day.
•
For trades received on a same day settlement basis, IM will initially be calculated based on a
synthetic allocation of bonds.
•
Once the settlement allocations are known, positions will be margined based on the actual
allocations as part of all subsequent margining processes.
•
Initial margin offsets will be supported between Term £GC trades and trades executed against
specific collateral cleared via the existing Gilts market.
Variation Margin
•
Variation Margin will be called to reflect the change in the net present value of the repo interest
only.
Delivery Margin
•
Delivery Margin will not be applicable to Term £GC (as per Sterling GC).
44
Risk Management
Intra-day Risk Management
• Term £GC will utilise the standard CREST TDBV functionality which adjusts collateral levels on a
daily basis to ensure that the value of collateral appropriately covers the cash value of the
transaction.
• This will be augmented with an additional level of market risk management by
LCH.Clearnet
S+ 1
S
15.00 - 16.10
DBV settlement
CREST (Allocation
based on
previous day’s
prices)
17.30
Today’s
prices
available in
CREST
16.30
LCH.Clearnet
Allocation
details
45
LCH.Clearnet
perform new
Intraday Risk
evaluation on
allocations.
Margin called and held
overnight in USD
07.10 –14.47
CREST Mark To Market (MTM) via a TDM transactions (based
on yesterday’s prices)
Crest
Evaluation
File
If Client has satisfied the
CREST MTM then the
previous evening’s margin call
returned by 10am
Intraday Margin Processes at:
09.10 , 10.40, 13.00, 15.30, 16.30.
Settlement Netting
The settlement netting process for Term £GC will be run as two independent steps: “Term Netting” and
“End Date Netting”
+£100mn
Trade 1
• As per the graphic, in the Day 1
Term Netting process, trades 1 and
2 are netted to produce a
settlement instruction for +£30mn
Trade 6
NET
Term Date Netting
• The Term Netting process will seek
to
offset trades for which
settlement will
be instructed “Today” (Day1 in the
graphic) where trades have the
same start and end date.
-£20mn
Trade 3
-£20mn
Trade 4
-£25mn
NET
Trade 5
+£250mn
+£250mn
NET
Trade 7
-£25mn
Trade 8
1
End Date Netting
-£70mn
Trade 2
2
3
4
5
6
7
8
Day
• This process examines the positions that have been instructed for settlement in CREST previously and
determines whether those existing positions can be increased or decreased in size, or potentially
terminated in order to minimize the level of open positions within the TDBV settlement platform for the
participant.
• On Day 1 there are no positions that have been previously instructed for settlement, so no End Date netting
takes
46 place.
Settlement Netting
TDBV Settlement Position in CREST following Day 1 netting
Settlement position
• As a result of the netting and settlement
instruction which took place on Day 1, there is
now a settlement position in place in CREST for
+£30mn which has an end date of day 7.
Opening leg
settlement
Closing Leg
Settlement
1
+£30mn
1
2
3
4
Day
5
6
7
8
TDBV Settlement Position in CREST following Day 2 netting
• On day 2, there is only a single trade for the
counterparty so no Term Date netting can take
place.
• Thus, the new trade and the existing position
are End Date netted and the existing TDBV
position in CREST is reduced from £30mn to
£10mn.
47
Settlement position
• However the trade for -£20mn with an end leg
settlement date of the day 7 must be considered
for End Date netting.
Opening leg
settlement
1
Closing Leg
Settlement
+£30mn
+£10mn
Size of settlement
position reduced as a
result of Day 2 netting
1
2
3
4
Day
5
6
7
8
Settlement Netting
Repo Interest
• A separate netting process is utilised with respect to repo interest payments such that, on a daily
basis, a single net repo interest payment in respect of all closing trades is instructed to CREST for
settlement as a cash-only payment .
• This mirrors the process that is used in the current Sterling GC product.
Settlement Instruction
• LCH.Clearnet submits all settlement instructions using the CREST Direct Input facility so that
participants do not need to instruct or match in CREST themselves as a “business as usual”
activity.
• This facility is used for all settlement instruction including the amendment of the size/early
termination of settlement positions.
48
Substitution of Collateral
• The use of collateral substitution within the Term £GC product is twofold:
•
In line with the bilateral market, substitution will be used by collateral givers where a specific
bond is required in relation to a participant’s Delivery vs. Payment or Free of Payment
transaction.
•
In relation to the Term £GC product specifically, substitution transactions will be automatically
generated to support the return of the correct collateral to its original giver as part of the end
leg settlement process.
• The volume of substitution transactions which could be generated as a result of collateral return
process may be significant:
• On any given day there are likely to be multiple givers of collateral to LCH.Clearnet and
multiple recipients of collateral from LCH.Clearnet.
• Collateral delivered to LCH.Clearnet on an overnight basis may be allocated to a collateral
taker on a term basis.
• It is essential that collateral which is allocated to participants as a result of the settlement of Term
£GC trades is available for substitution using standard CREST Term DBV functionality.
• Any costs incurred by LCH.Clearnet as a result of substitution failure in these circumstances will be
charged to the member who fails to support the requested substitution.
49
Tariff Structure
Registration Fees
•
Registration fees for Term £GC trades will be charged on an ad-valorem basis as per the below
table using a 360 day count convention:
The first 1-7 days @ 0.00275%
The next 8-90 days @ 0.00225%
The next 91+ days @ 0.00100%
•
In addition, a processing fee of £0.70 is levied per registered trade.
•
This fee structure is the same as that which is currently in place for Sterling GC.
Settlement Fees
•
50
Settlement related costs incurred by LCH.Clearnet in settling participants’ Term £GC positions
in the EUI Term DBV settlement system will be recovered from participants.
Programme Timeline
What is available now?
•
Clients wishing to clear Term Sterling GC will need to interact directly with the CREST TDBV
system. The CREST TDBV test environments are already available for Clients to utilise in their
internal development processes.
•
The Term £GC product description is published which can be used as a basis for Participants
internal development processes.
Implementation timeline
•
Additional technical specifications will be available from both LCH.Clearnet and EUI in September
2013.
•
EUI are developing additional functionality for LCH.Clearnet to support Term £GC, which is
scheduled to go live on 17 March 2014.
•
LCH.Clearnet Member testing scheduled to commence February/March 2014.
•
Term £GC will go live in April 2014, following a period of around a month of the CREST changes
running in the production environment.
51
Transition of Liquidity to Term £GC
•
Following the go-live of Term £GC, the current Sterling GC product will be continue to be available for
a period of time and the two products will be supported in parallel.
•
Whilst pragmatic as a short term solution, this approach is likely to lead to an undesirable split of
liquidity across the two products.
Volume
Term £GC
•
Will seek to create an environment where a high proportion of existing
Sterling GC users are able to trade the new Term £GC product from
launch such that there is a natural transfer of liquidity into Term £GC.
•
At a point in time three months after the launch of Term £GC it is
proposed to withdraw the Sterling GC product such that new trades
can no longer be registered.
•
£GC
Time
Based on the current maturity profile of Sterling GC, 99% of all open trades would mature within the 3
month period leaving only a small proportion of trades to be transferred across to the new product.
52
Contacts and Additional Information
For further information on the Term £GC product, please contact:
Manisha Mistry
Email: Manisha.Mistry@LCHClearnet.com
Tel:
+44 20 7426 7199
Or
Nick Maggs
Email: Nick.Maggs@LCHClearnet.com
Tel:
53
+44 20 7426 7442
Cleared Term DBV
23 July 2013
Cleared Term DBV
Sub-group Update
Member Actions Required
Ian Fox
23 July 2013
55
PROGRESS SO FAR
 Initiative launched by Chris Salmon 24th Jan 2013 – speech to LMMA
 Sub-group of MMLG created to co-ordinate the work required to introduce and
adopt the new product
 Sub-group includes representatives from EUI, CREST, LMMA, DMO, ISLA, Bank
of England, major repo trading banks
 Product design proposed by LCH / EUI and agreed
 Implementation timelines drawn up
 Changed cost impacts assessed
 Market discipline regime agreed
56
MARKET ADOPTION IS KEY
 Objective has always been to get widespread support to ensure good market
liquidity
 Aim of the sub-group is therefore ensuring that the product is fit for purpose for
market participants and they are ready to use it – this is key to finalising the
implementation process
 Sub-group has been widened to ensure greater representation
 Communication of CTDBV plans through:
 MMLG
 SLRC
 LMMA
 ISLA
 BBA
 Major market traders
57
MEMBER ACTIONS REQUIRED
 Expectation that new CTDBV product will be introduced in mid 2014 – so
preparations should begin now if not already started:
 Full understanding of product design, settlement routine changes
 Asses impact on existing business / trading habits
 Scope changes to existing processes / habits
 Model cost impacts
 Engage with LCH / EUI as necessary (detailed documentation available on
websites)
 Ensure suitable collateral position monitoring and management
 Timely focus on IT changes (if required)
 Commit resources to market testing of both BAU and migration process
 Existing LCH DBV product will be discontinued after a short period of parallel
running (EUI o/n DBV product will continue)
58
LLOYDS – PREPARATIONS UNDERWAY
 Front Office and Back Office have been engaged on the project since January.
 Full understanding of product and changed trading and settlement requirements.
 Little technical IT changes required.
 Main action is to segregate CTDBV from trading inventory – separate CREST
accounts and enhanced Front Office MI.
 Modelling of settlement / trading cost impacts has been performed.
 Review of policy and procedure documents – including second line oversight
review.
 Will be fully engaged in testing. Counterparty engagement to follow.
59
NEXT STEPS
 Sub-group will continue to steer through CTDBV – particular focus on testing
outcomes
 Continued communication as wide as possible
 Comments / issues welcomed
 Bank of England will write to market participants in September to get confirmation
of market readiness
 New product could be used to term out current large o/n DBV positions used to
collateralise stock borrowing transactions
60
GOOD PRACTICE FRAMEWORK
 Fails – not acceptable, but no financial penalties beyond recharge of costs
incurred
 Exploring feasibility of daily fails reporting
 Exploring feasibility of system flags to avoid stock being removed from the CTDBV
cycle
 Existing EUI / LCH rules to apply, updated as required
 Bank of England to update 2011 “TDBV Good Market Practice” document
 Eventual update to Gilt Repo Code of Conduct
 Default position is that “trading to fail” is unacceptable, accidental fails should be
avoided
61
QUESTIONS
62
Closing remarks
Ian Mair: Chair, London Money Market Association
email: itmconsulting@btinternet.com
www.LMMA.org.uk
Cleared Term DBV
23 July 2013