Financial Markets Operations Management (50 page)

We have seen in this chapter that securities financing consists of collateralised lending transactions of one form or another. Collateralisation is one of the tools used to mitigate counterparty risk (i.e. the risk that one or other of the counterparties defaults). The use of master agreements, haircuts and margin also helps in this process.

The master agreements for repo and securities lending contain provisions for unwinding transactions should a default occur. First, though, we need to know what event(s) could cause a default.

Both agreements contain similar descriptions of what constitutes an event of default. You will find a summary of the events in each agreement's Section 10.

There are similarities in the way in which the obligations between buyer/seller (GMRA) and lender/borrower (GMSLA) are treated. Of the two parties involved, one will be the defaulting party and the other the non-defaulting party. The first step will be the delivery of a default notice by the non-defaulting party to the defaulting party.

Should an event of default occur, both parties' payment and delivery obligations to each other are replaced by a single obligation of one party to pay a cash sum to the other. It is the non-defaulting party that determines the amount of cash payable by determining the market value (referred to as the
default market value
) of deliverable and receivable securities together with cash collateral and any other cash.

This reduction of all the obligations into one single obligation is a key element of the agreement, as this netting should ensure that that the non-defaulting party receives or pays the correct
amount. Netting also helps to prevent the defaulting party from utilising some of the collateral to offset other obligations.

You can refer to the actual agreements for more details:

• 2010 GMSLA (as amended July 2012) – Paragraph 11: Consequences of an Event of Default (pp. 19–23).
  
• 2011 GMRA – Paragraph 10 (b) to (g) and (j) to (n) (pp. 18–24).
  

We looked at clearing houses and CCPs in Chapter 5 and noted their key role in the post-trade environment. Not all of these provide specialist services for securities financing, although this situation is changing.

Except for transactions that are executed using the alternative trading systems (ATS), securities financing has been an OTC product with bilateral negotiation. The post-transaction processing was predominantly managed in-house using internal systems and/or external, third-party solutions.
⁹

The clearing houses and CCPs would be involved at the delivery and payment stages; in fact, the clearing houses may not necessarily have been aware of the purpose of delivery and payment. This situation has changed and continues to evolve, with regulatory demands for OTC transactions to be cleared centrally. This results in the clearing houses and CCPs becoming involved much sooner after a transaction.

In this final section we will take a look at three CCPs and the two international CSDs that operate in this business:

• The Options Clearing Corporation (CCP) –
  www.theocc.com
  
• Eurex Clearing (CCP) –
  www.eurexclearing.com
  
• LCH.Clearnet (CCP) –
  www.lchclearnet.com
  
• Clearstream Banking Luxembourg (ICSD) –
  www.clearstream.com
  
• Euroclear Bank (ICSD) –
  www.euroclear.com
  

The OCC manages two programmes in which it acts as a CCP on behalf of its clearing members:

1. Stock Loan/Hedge Programme:
   This programme allows lenders and borrowers to negotiate bilaterally and send their instructions to the OCC, where they are processed through DTC's systems. Settlement takes place at the DTC with the OCC managing the mark-to-market processing, margin requirements and reporting. DTC handles any corporate actions.
   
2. Market Loan Programme:
   Similar to the StockLoan/Hedge Programme above, this programme differs insofar as the OCC is acting as a clearer for transactions executed on AQS, an automated marketplace for securities lending and borrowing. Loans executed on AQS are processed through the OCC acting as a CCP.
   

Eurex Clearing offers CCP services for both securities lending and repo transactions.

• Lending CCP service:
  Participants can execute transactions either bilaterally on electronic trading platforms such as SL-X (
  www.sl-x.com
  ) and Pirum (
  www.pirum.com
  ). Clearing services for loans in equities, fixed-income securities and ETFs in the European markets are covered. Cash collateral (USD and EUR) and non-cash collateral are accepted. Non-cash collateral includes the following securities types:
  
  • Bonds issued by the major central governments (e.g. USA, Japan and Luxembourg, etc.);
    
  • Bonds issued by the supranationals (e.g. EBRD, IBRD, EIB, etc.);
    
  • Bonds issued by the European Central Bank and Swiss National Bank;
    
  • Repo-eligible corporate bonds (AAA to BBB);
    
  • Equities listed in the major indices from Europe, Asia-Pacific and North America (e.g. CAC40 – France, S&P ASX20 – Australia and S&P TSX60 – Canada);
    
  • Selected ETFs.
    
  • (NB: Structured bonds are excluded.)
    
• Euro repo market:
  Participants can trade anonymously in both general collateral and specials segments with Eurex Clearing acting as a CCP. There are some 5,000 EUR-denominated fixed-income securities (divided into 21 different baskets) available for repo trading in both segments. The available securities consist of:
  
  • European government bonds;
    
  • Jumbo-Pfandbriefe and Pfandbriefe;
    
  • KfW/Laender bonds;
    
  • European covered bonds;
    
  • Agency bonds;
    
  • European corporate bonds.
    
• GC pooling market:
  This market operates an open order book that provides participants wishing to obtain secured USD and EUR funding with anonymous trading. Eurex Clearing will process the transactions and enable participants to re-use collateral for further money market transactions. Participants can select collateral from standardised baskets of fixed income and equities that are tradable in USD and EUR.
  

LCH.Clearnet clears repo trades through its RepoClear service. It accepts classic fixed-rate repos with first leg settlement on
T
+0 or with a forward start with a term of up to 12 months. RepoClear clears transactions in the following government bond markets:

• Austria
  
• Belgium
  
• Finland
  
• Germany
  
• Ireland
  
• Portugal
  
• Slovakia
  
• Slovenia
  
• Spain
  
• United Kingdom
  
• German Jumbo-Pfandbriefe
  
• Supranationals, agency and sovereign bonds.
  

RepoClear can accept transactions executed directly, by voice broker and screen trading systems (ATSs) with LCH.Clearnet assuming the counterparty risk through novation.

For transactions that are delivery settled, RepoClear nets all deliveries due for next-day settlement, resulting in one delivery of securities against a single payment. Settlement netting might result in multiple deliveries depending on cross-border settlement requirements or limits on the maximum delivery size.

Where no actual bond delivery takes place, the cash amounts from both ATS-and bilaterally-traded transactions are netted out per currency and paid through the protected payments system (PPS).

CBL manages two automated securities lending services for participants and manages all the administrative activities:

• Automated Securities Lending and Borrowing (ASL):
  CBL automatically identifies ASL lenders' available positions and attempts to cover ASL borrowers' failed trades. CBL acts as a lending agent, collateral agent and guarantor so that the lenders and borrowers are unknown to each other. As soon as the borrowers' failed trades have settled, CBL returns the bonds to the lender. If the lenders subsequently sell their loaned bonds, CBL recalls them.
  

  CBL also provides a case-by-case variation of ASL allowing participants to manage their own strategies (e.g. a participant might choose to delay borrowing to cover a failed transaction).
  

  Collateral is pledged to CBL as guarantor and its quality and quantity monitored by CBL on a daily basis.
  

• Securities Lending Services (ASLplus):
  If ASL is a short-term fails prevention tool for the participants' Operations departments, ASLplus is geared to borrowers wishing to consider longer-term opportunities and lenders wishing to maximise the returns on their portfolios. CBL acts as principal borrower, typically lending to proprietary desks, repo desks and other intermediaries (i.e. the Front Office).
  

Euroclear enables its participants to manage their settlement fails by automatically borrowing sufficient bonds from lenders in order to settle the transactions. Acting as agent, Euroclear
identifies the borrowing requirements, administers the asset servicing and manages recalls as they are needed.

Participants can tailor their participation in the lending programme by excluding certain asset classes or individual securities (e.g. lending only USD-denominated Eurobonds, excluding bonds issued by a particular issuer). The provision and revaluation of collateral is also managed by Euroclear.