Cleared Term DBV 23 July 2013 - LMMA
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Cleared Term DBV 23 July 2013
Transcript of Cleared Term DBV 23 July 2013 - LMMA
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
0
20
40
60
80
100
120
Unsecured Secured
£ billionsAggregate Interbank
Average daily turnover in sterling money market (Nov 2012)
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!
0
20
40
60
80
100
120
140
160
180
200
Oct Jan Apr Jul Oct Jan Apr
2011
Value of open Term DBV
Value of overnight DBV settled (not counting unwinds)
£ billions
2013 2012
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
Toby Davies
Head of Market Services Division
23 July 2013
The case for change
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
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Clearing Term DBV
Bank of England Seminar
23 July 2013
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•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)
Functional Overview
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•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)
Functional Overview
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•Simple Substitution (Bilateral model)
•Day 1: delivers £100m DBV (UBG) 7 day term
•Day 2: Party A delivers £25m gilt 1 to Party C
Recall Substitution
Party A Party B £75m Gilt 3
£25m Gilt 1
£50m Gilt 2
£25m Gilt 3
Party C
DEL £25m
Gilt 1
Sub (TDG) £25m Gilt 1
Sub (TDG) £25m Gilt 3
Party A £100m Gilt 3
Party B £50m Gilt 1
£50m Gilt 2
DBV £100m UBG
7 day term
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•Complex Substitution ►CCP is less vulnerable to subs fails given the large number of
counterparty holdings
Recall Substitution
LCH
Mbr A
Mbr B
Mbr C
Mbr D
Mbr E
Mbr F
Mbr G
Mbr H
Mbr I
Mbr X Mbr H
TDG £5m Gilt 2
TDG £5m Gilt 1
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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
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•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
Market Practice
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•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
Account Segregation
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•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
Single Account
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•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
DBV Reporting Tools
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•Test Environment available for testing Term DBV functionality
•Block Booking – Nov/Dec 2013
•No charge for testing during this period
Testing Availability
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Cleared Term DBV 23 July 2013
Term £GC
Product Overview
Bank of England
23 July 2013
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Term £GC Overview
GB00B1347K44
GB00BC7H8L40
TDBV Settlement DBV Settlement
Term £GC
Product Definition
Sterling GC
Product Definition
Trading
Settlement mechanism
Features of cleared product
Sterling
GC
Term £GC
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.
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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.
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Term £GC – Trading, Clearing and Settlement
LCH.Clearnet
RepoClear Participant
Voice
Brokers
(via ETCMS)
Electronic
Trading
Platforms
CRESTSettlement
NettingTrade
Registration
Risk Management
Execute
Term £GC
Trade
Match
Trade
Term £GC trade
Term £G
C trade
Trade
Acceptance
Message
Trade &
Position
Reports
Margin
Reports
Netting &
Shaping
ReportsManage
Funding
TDBV Instructions
Repo Interest
Instruction
Allocation
informaton
Manage
collateral
allocations,
substitutions
and returns
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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
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Risk Management
• 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).
Initial Margin
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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
Intra-day Risk Management
S S + 1
15.00 - 16.10
DBV settlement
(Allocation
based on
previous day’s
prices)
17.30
Today’s
prices
available in
CREST
16.30
LCH.Clearnet
perform new
Intraday Risk
evaluation on
allocations.
07.10 –14.47
CREST Mark To Market (MTM) via a TDM transactions (based
on yesterday’s prices)
Intraday Margin Processes at:
09.10 , 10.40, 13.00, 15.30, 16.30.
Margin called and held
overnight in USD
If Client has satisf ied the
CREST MTM then the
previous evening’s margin call
returned by 10am
CREST
LCH.Clearnet
Crest
Evaluation
File
Allocation
details
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Settlement Netting
The settlement netting process for Term £GC will be run as two independent steps: “Term Netting” and
“End 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.
• As per the graphic, in the Day 1
Term Netting process, trades 1 and
2 are netted to produce a
settlement instruction for +£30mn
Term Date Netting
-£25mn
+£250mn
-£70mn
+£250mn
-£25mn
+£100mn
1 2 3 4 5 6 7 8
Trade 1
Trade 2
Trade 3
Trade 4
Trade 5
Trade 6
Trade 7
Trade 8
Day
NE
T
NE
T
NE
T-£20mn
-£20mn
• 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 place.
End Date Netting
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Settlement Netting
• 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.
• On day 2, there is only a single trade for the
counterparty so no Term Date netting can take
place.
• However the trade for -£20mn with an end leg
settlement date of the day 7 must be considered
for End Date netting.
• 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.
TDBV Settlement Position in CREST following Day 1 netting
TDBV Settlement Position in CREST following Day 2 netting
+£10mn
1 2 3 4 5 6 7 8
Se
ttlem
en
t po
sition
Day
Opening leg settlement
Closing Leg Settlement
1 +£30mn
Size of settlement position reduced as a result of Day 2 netting
+£30mn
1 2 3 4 5 6 7 8
Se
ttlem
en
t po
sition
Day
Opening leg settlement
Closing Leg Settlement
1
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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.
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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.
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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
• 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.
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Programme Timeline
• 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.
• 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.
What is available now?
Implementation timeline
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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.
• 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.
• 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.
£GC
Term £GC
Time
Volume
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Contacts and Additional Information
For further information on the Term £GC product, please contact:
Manisha Mistry
Email: [email protected]
Tel: +44 20 7426 7199
Or
Nick Maggs
Email: [email protected]
Tel: +44 20 7426 7442
Cleared Term DBV 23 July 2013
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Cleared Term DBV Sub-group Update Member Actions Required Ian Fox 23 July 2013
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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
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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
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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)
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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.
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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
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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
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QUESTIONS
Closing remarks
Ian Mair: Chair, London Money Market Association
email: [email protected]
www.LMMA.org.uk
Cleared Term DBV 23 July 2013
