14 June 2012

Bank of Canada/Agathe Côté: Strengthening financial infrastructure - the new Canadian central counterparty

Global financial conditions have deteriorated markedly in recent weeks as the debt crisis in Europe has intensified. Markets are sceptical about the capacity and resolve of policy-makers to address unsustainable fiscal situations, the capital adequacy of some euro area banks and the underlying balance-of-payments problems within the euro area. If these issues are not dealt with in an orderly way, the contagion effects on global financial conditions could be significant.

To date, the crisis in Europe has had a limited impact on our financial system. Canadian markets have remained relatively stable, and our banks continue to have good access to wholesale funding markets. Nonetheless, a deterioration in the situation could have a considerable effect on Canada through trade, confidence and financial channels.

Repo markets in Canada suffered a severe liquidity crunch in the autumn of that year. Following the bankruptcy of major financial institutions abroad, concerns about counterparties spread, and balance sheets were subject to severe strains. In the absence of a CCP that would allow its members to ease their balance sheets through balance-sheet netting, banks drastically curtailed their repo activity. The crisis clearly demonstrated the need for action to bolster the resilience of this market.

Developing the new infrastructure took a great deal of time. It is a complex process, in terms of both creating and implementing adequate and robust risk-control mechanisms. Moreover, time is required to resolve operational issues, such as the development and testing of required software for both the central counterparty and the participants, and issues associated with the interaction between new software and existing systems.

The launch of the first phase of the service therefore represents a major step. But much remains to be done. Delivery will take place in three phases.

• Phase one deals with bilateral repo transactions on a single Government of Canada security, although these represent only a small fraction of the market.
• Phase two, planned for the end of this year, will incorporate cash transactions on fixed-income securities and repo transactions negotiated by intermediaries, including those with anonymous counterparties.
• Finally, phase three, proposed for 2013–14, will target general-repo transactions in which any security in a predetermined basket of instruments can serve as collateral. The introduction of this last phase is expected to significantly increase the volume of trades made through the central counterparty, as well as the liquidity and efficiency of the repo market.

Full speech

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