Regulators have introduced a flurry of new capital rules to bolster risk standards, but that has prompted many banks to reduce their activity due to higher costs. In particular, a bank leverage ratio gives minimal relief to banks borrowing cash with one counterparty and lending to another. In both the US and the eurozone, repo activity has been curtailed.
A key issue is whether pushing more activity through clearing can alleviate the capital costs of tougher new rules and thus help stabilise repo activity. A sticking point is whether large investors — due to operational restrictions — can move in this direction, while others object to the potential for higher costs involved away from the current model. Processing repo trades through a clearing house would allow more positions to offset each other, lowering their overall exposure and alleviate banks’ capital constraints. Matching the trades in a clearing house, with a confirmed counterparty, would also give funds better prices for their deals
“Facing one central clearing house that is well established and has all the right infrastructure in place to handle the market, I think it makes more sense to clear there, than trade directly with the banks,” says Michael O’Brien, head of global trading at Eaton Vance. But for all the talk, the industry response has been slow and the problem resides in the complexity of how a clearing house functions. Usually they collect additional funds from members that are put aside to cover losses in case of default.
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