DEEP LOOK | The European securities services industry is being urged to maintain its stance – that of taking a different approach to the US on the issue of mandatory clearing of repo transactions. Paul Golden takes a closer look.
In late 2023, the US Securities and Exchange Commission (SEC) finalised a rule requiring repo market transactions to be cleared through a covered clearing agency – a registered clearing agency that serves as a central counterparty or central securities depository – by the end of June 2027.
The securities market regulator claims this will enhance market transparency, reduce counterparty risk, and improve stability.
But while the US has historically led the way when it comes to clearing mandates – for example, clearing of credit default swaps and interest rate swaps – Europe has a track record of interpreting international standards to fit its unique market features.
A different beast
As Elina Lehtonen, vice president of cross-asset sales EMEA at Eurex, puts it in her interview with PostTrade 360° here, the European repo market is very different to that of the US, characterised as it is by fragmented capital markets, multiple domestic issuers, and diverse market infrastructure.
Mike Brown, global head of cash reinvestment at JP Morgan reckons that Europe will need to take a different approach to the US regarding mandatory clearing given the differences in market structure, existing clearing penetration in underlying markets, and legal frameworks. “A single mandate across this diverse set of markets may not be the best approach,” he says. “Tailored, targeted reforms may be more effective, alongside improved infrastructure to remove or reduce operational barriers to entry, to enhance access models for participants.”
While the US is a single financial market, the landscape in Europe is a lot more diverse and achieving a single solution would be challenging. That is the view of Conard Schweizer, vice president, financing solutions sales Europe at State Street, who expects ongoing regulatory pressure to make financial markets more resilient while keeping as many different players in the game as possible.
“Mandatory clearing is possible but a single provider like there is in the US today is unlikely,” he says. “In fact, we know there will be competition to this market including from CME and ICE and perhaps other CCPs. The process of laying the regulatory and legal groundwork for this is ongoing.”
Jumping operational hurdles
State Street’s perspective is that the European market first needs new voluntary liquidity channels to improve market access. This could include new access models to liquidity for the buy-side in cleared markets, or through efficient financing and guaranteed structures.
Based on this view, in Europe, State Street is investing in facilitating liquidity through both clearing and peer-to-peer guarantee structures, whereby both models remove a key market hurdle to liquidity channels and open up new market connectivity.
Lehtonen observes that European pension funds, insurers, and asset managers are increasingly clearing repo voluntarily to optimise liquidity and capital. For this trend to continue, the operational aspects of repo clearing must also be considered.
Onboarding and operational requirements are a key consideration for participating in central clearing, which includes the complexities in the custodial set-up required to support connectivity for buy-side clients, acknowledges Brown. “This is in addition to ongoing transaction costs and will likely continue to impact access for potential participants,” he says. “The SEC’s US Treasury clearing mandate implementation date was put back to 30 June 2027 for repo to provide participants with further time to manage the difficulties of implementation. Reducing the operational requirements and complexities will lead to more participants utilising central clearing.”
European pension funds, insurers, and asset managers are increasingly clearing repo voluntarily to optimise liquidity and capital.
He agrees that the benefits of voluntary clearing are generally appreciated across the market. “Improvements in trading liquidity and capacity available in cleared markets are key here,” he adds. “Dealer balance sheet netting, potential capital cost efficiencies, and a broader array of diversified counterparts versus traditional bilateral arrangements create the potential for improved pricing and more stable liquidity access when market liquidity is impeded by stress events or reporting periods.”
Schweizer says he has seen buy-side clients with several funds onboard only their biggest funds because even repeating a known set-up process involves too much work and cost. “Even though that obviously makes a lot of sense from an onboarding and operational workload perspective, it can lead to a situation where smaller funds are left with fewer or – in a worst-case scenario – suboptimal avenues to allocate cash,” he continues.
Of own accord
The asset management and pension fund/insurance communities have witnessed the increased price transparency, liquidity, and tighter spreads caused by clearing in other financial products. “Market participants are well aware that clearing reduces other mandatory tasks such as margining or valuations,” says Schweizer. “This is a big driver to automate trading and lower settlement and risk management hurdles in these products. Other potential market participants, such as corporate treasurers, have often been restrained by relatively high market entrance barriers but are currently starting to explore this space. Opening the door for UCITS funds or AIFs could add even more liquidity to the market.”
Frank Odendall, managing director of Eurex Repo suggests that the greatest complexity for clients lies in the onboarding process. “While they might have experience of derivatives clearing, there is typically a different technology stack behind repo that can create issues for the operations department of buy-side and even sell-side entities,” he says. “Putting a project team in place to manage implementation is important.” In his experience, client onboarding has been dominated by real money clients such as pension funds and insurance companies.
Market participants are well aware that clearing reduces other mandatory tasks such as margining or valuations.
Onboarding requirements and integration costs for repo clearing can be a barrier to entry for European buy-side firms. That is the view of Janina Marks, head of sales and business development for derivatives and post trade at Euronext, who says her organisation has taken a different approach.
Marks believes European buy-side firms are starting to recognise the value of voluntarily clearing repo transactions, particularly when they need to access a broader pool of liquidity “They also appreciate what clearing houses can do in terms of mitigating counterparty risk,” she says. “Adding new bilateral counterparties requires significant operational resources, whereas with central counterparty clearing, firms can connect to the clearing house directly or via a member.”
According to Odendall, one of the reasons why take-up has not proceeded more rapidly is that buy-side firms would normally use a custodian to set up securities and repo transactions and there has not been much activity from custodians in European cleared repo markets. “However, the large US-based global custodians have embraced the proposition of clearing for repo in Europe as well,” he says. “With that comes their massive client franchise and we are now working with them to make the settlement of repo transactions a seamless exercise.”
Tools that empower
During an interview with PostTrade 360° at WFEClear in April, Stéphane Janin, head of global regulatory developments and public affairs for AXA Investment Managers suggested that CCP risk models and simulation tools could be more transparent. But Schweizer notes that CCPs have withstood and buoyed markets through some of the largest institutional failures observed in the great collateral financial crisis and the shock of the pandemic as well as other recent events. “The risk models of these institutions are stringently governed to ensure they can withstand severe shock scenarios in order to provide ongoing market functioning and liquidity during stress events,” he says.
While modelling documentation is generally made publicly available, the evolution of simple quantitative portfolio management tools is becoming a common theme across CCPs, empowering the CCP member to better manage their balance sheet and risk footprint. “With the convergence of clearing across multiple products gaining momentum in the US and EMEA, we expect to see acceleration of cross-product margining and tools available to better manage a multi-product portfolio,” says Schweizer. “We envision these tools will be leveraged by the buy-side as well as the sell-side.”
Repo clearing could also facilitate new trading strategies by hedge funds. While adoption success will be driven by platform factors such as liquidity, haircuts, pricing and clearing fees as well as legal, accounting, and operational efficiencies, any opportunities to cross margin across products through a single or multiple CCPs would be a big draw to many hedge funds.
Brown takes a cautious view though, suggesting that it would perhaps be more likely to provide opportunities to refine and scale existing strategies through improved efficiency and reduced financing costs. This applies particularly for those strategies that are reliant on secure and efficient financing, especially those involving fixed income arbitrage and collateral management.
Europe’s own path
The growth potential of the European money market funds sector as well as the scope for high capital efficiencies makes clearing more appealing, thus reducing the necessity for clearing obligations. In addition, the absence of homogeneous insolvency rules in Europe would make the imposition of mandatory clearing more challenging than on the other side of the Atlantic.
Marks believes there is opportunity in the European market to develop a model underpinned by a simple contractual framework and low touch onboarding for buy-side firms without waiting for a regulatory mandate. Euronext is building out its buy-side access clearing models which – subject to regulatory approval – will go live in mid-2026.
“Clients and sponsoring banks can have differing needs, whether that is capital efficiency from a bank perspective, or how clients deliver margin to the clearing house,” Marks concludes. “It is our job to develop flexible solutions to meet the various requirements of the market.”
