CONSULTATION PAPER ON A NEW REFERENCE INDEX FOR THE EURO REPO MARKET

Transcription

1 AL D CONSULTATION PAPER ON A NEW REFERENCE INDEX FOR THE EURO REPO MARKET 29th 56, Avenue des Arts 1000 Brussels +32 (0) info@emmi-benchmarks.eu

2 Acknowledgements. EMMI would like to thank the Chair of Finance and Systemic Risk at the University of St Gallen (Switzerland) for their work and support. The updated time series in Section 6 have been compiled by Professor Angelo Ranaldo and Patrick Schaffner (HSG). MTS Data is owned and supplied under licence by EuroMTS Ltd. Eurex Repo data is owned and supplied under licence by Eurex. EBS Brokertec data is owned and supplied under licence by NEX Data. Page 2

3 Contents Introduction... 5 Definition of the New Repo Index Components of the new repo index specification The underlying interest of the new repo index Statement of the determination methodology...7 Prospective use of the new repo index Use of the new repo index in the discounting of EUR IRS New repo index as a tool for transparency Updated historical analysis Data Analysis New repo index behavior List of respondents Page 3

4 List of figures Figure 1 // Baseline and existing repo indices, December Figure 2 // Repo market volume across ATSs, daily (EUR billion) 12 Figure 3 // Distribution of repo implied market share across ATSs, daily 12 Figure 4 // GC and specific repo transactions volume, daily (EUR billion) 13 Figure 5 // GC and specific repo implied market share, daily 13 Figure 6 // One-day repo volumes, daily, EUR billion 13 Figure 7 // One-day repo volumes, implied share 13 Figure 8 // Repo volumes across geographies, daily, EUR billion 14 Figure 9 // Repo volumes across geographies, implied share 14 Figure 10 // Baseline index, Eonia, and ECB policy corridor, Figure 11 // Baseline and Eonia indexes; aggregated daily volumes, Figure 12 // Baseline, Stoxx GCP, and RFR Euro indexes, Page 4

5 Introduction On 15th June 2017, the (EMMI) published its Consultation Paper on a New Reference Index for the Euro Repo Market. The Paper described EMMI s ongoing work, and sought the market s feedback on the proposed definition of the new repo index and its calculation methodology. The consultation period closed on 14th July 2017, and EMMI received 32 responses from a range of institutions, including banks, trade associations, asset managers, and others (see the list of respondents at the end of the document). This document provides a summary of the main issues raised by respondents, and explains EMMI s views on these aspects. The feedback also includes comments received in bilateral conversations between EMMI and stakeholders. As indicated in the consultation paper, at this stage, the focus is not the governance, publication, or potential or future licensing of the index. These topics will be addressed in separate communications as the project progresses. The feedback summary is organised as follows: Section 1 addresses the two-part structure for the repo index specification suggested by EMMI, while Sections 2 and 3 discuss each of these parts in more detail. Section 2 clarifies the statement of underlying interest of the new repo index, and Section 3 tackles the feedback received on various methodological aspects of the index. Section 4 provides a summary of the feedback received on potential uses of the proposed new repo index, and Section 5 summarizes the responses referring to the new repo index as a transparency tool for the repo market. In Section 6, EMMI provides an updated historical analysis, similar to the one presented in the consultation paper, with time series updated up to and including end-of-year Page 5

6 Definition of the New Repo Index 1 Components of the new repo index specification As mentioned in the June 2017 consultation paper, international regulatory best practice places a duty on the administrator of a benchmark to have procedures in place for the potential need for its evolution. The Principles for Financial Benchmarks published by the International Organization of Securities Commissions (IOSCO) recommend benchmark administrators regularly review conditions in the benchmark s underlying market in order to determine whether changes to the design of the benchmark methodology might be necessary. 1 The EU Regulation 2016/1011 on indices used as benchmarks also addresses this issue throughout the text. 2 In light of these requirements, EMMI proposed to distinguish between the underlying interest of a benchmark, which defines the market or economic reality that the index seeks to measure; and the statement of the index s determination methodology, which describes how the underlying interest is to be measured. Combined, these are considered to be the benchmark specification. All respondents provided feedback that EMMI s proposed structure for the new repo index s specification was appropriate. Respondents agreed that the distinction between the economic reality the index intends to measure, which constitutes the durable component of the specification, and the means to measure such reality, has the potential of minimizing risks, in case an evolution of the index is deemed necessary. 2 The underlying interest of the new repo index In the consultation paper, EMMI proposed the following statement of underlying interest for the new repo index: [The New Repo Index] represents the average rate of return of secured wholesale onebusiness-day maturity transactions in euro. The majority of respondents agreed with EMMI s proposed statement, not raising concerns on the definition of the market reality the index seeks to measure. The feedback indicated, however, that the use of the term secured in the definition of the underlying interest could give rise to misinterpretation, as other secured instruments, in particular securities lending agreements, could be thought as within the scope of the index. In order to avoid any confusion, EMMI has made the appropriate changes to the wording of the statement of underlying interest, which now reads: [The New Repo Index] represents the average rate of return of secured wholesale onebusiness-day maturity repo transactions in euro. 1 See Principle 10. Periodic Review in FR07/13, Principles on Financial Benchmarks, Final Report, IOSCO, July 2013, 2 See Article 11 (input data) and Article 28 (changes to and cessation of a benchmark) of the EU BMR, Page 6

7 Other comments received in response to EMMI s question on the underlying interest seem to ultimately address characteristics of the index specification that concern the index methodology. EMMI wishes to emphasize that the underlying interest of an index reflects the economic concept the index intends to measure, and should be phrased in broad, yet clear, terms that guarantee its durability over time. The statement of methodology, in turn, defines the criteria and procedures that are used to determine the benchmark, including, for example, input data and the aggregation methodology that ultimately provides the measure of the underlying interest. 3 To this end, EMMI has not made further changes to the wording of the statement of underlying interest on the basis of comments that addressed methodological considerations. 3 Statement of the determination methodology In order to assess the feasibility and robustness of a reference index based on the electronically-traded euro repo market, EMMI analyzed transaction-level data contributed by BrokerTec, Eurex Repo, and MTS Repo. The consultation provided a full report on the findings of the analysis and sought feedback on some of the methodological choices made by EMMI and the task force (hereafter referred to as we ). EMMI received comments on the choice to restrict the definition of the index to one-business-day transactions. According to the feedback, while one-day trading represents the majority of interbank transactions, it does not characterise institutional investor transactions, which typically have longer maturities. EMMI understands the need for a reliable and robust risk-free benchmark with a term structure, and appreciates use limitations of a one-day index. The analysis of repo data, as explained in the consultation, concluded that the large majority of electronically-traded repos (around 95%) are done with one-day maturities, with this share having remained relatively constant over time. Considering EMMI s goal to build a pan-european repo index, in which real transactions are the only input, EMMI discarded the possibility of developing indices covering other maturities on the curve. For the reader s convenience, we have included below a table indicating the number of days with little to no observations for different tenors during the period (as shown in the June 2017 consultation paper). For example, 72.7% of days in the sample period ( ) contained less than 10 eligible non-zero transactions with a 1 month maturity N in % N in % N in % One day W W W M M M M M Y As mentioned in the June 2017 consultation, this distinction has been made and used by EMMI and other benchmark administrators in the context of other benchmark reforms and reviews; see, for example, EMMI s Position Paper on the Evolution of Euribor (2015), the of England s definition of SONIA in their October 2016 public consultation on the reform of SONIA, and EMMI s definition of EONIA in the recently published EONIA Governance Framework. Page 7

8 Alignment of trades by settlement date. EMMI proposed to aggregate all one-day tenors into one single index, in order to guarantee data sufficiency. Our choice was also made based on the consideration that, if aligned by their settlement date, all transactions provide funding over the same period. All respondents supported EMMI s proposal, highlighting, in most cases, the appropriateness of this approach, especially around month-, quarter-, and year-end. Inclusion of floating rate transactions In the consultation paper, EMMI reported on how, while the vast majority of repo transactions in the dataset were conducted at a fixed rate, repo trades with French collateral tend to be conducted at a floating rate. The analysis also revealed that these transactions are typically indexed to Eonia. EMMI sought feedback on the decision to include repo trades conducted at a floating rate as eligible in the calculation of the repo index: we considered that not including them would leave a large number of repo transactions with French collateral outside of the scope of the index. This would be against the pan- European definition of the index. The majority of respondents agreed with EMMI s proposal to consider repos conducted at a floating rate as eligible input. Further qualifying criteria for the index referenced in these transactions will have to be defined, mainly to avoid potential future self-reference. One respondent considered that the volume contributed by repo transactions conducted at a floating rate does not justify their inclusion. The analysis performed by EMMI, and included in the June 2017 consultation paper, seems to indicate that, during the period , French floating repos amount to about EUR 30 billion of daily repo activity in the market (see Section 2e, Figure 22, and Figure 23). EMMI and the task force consider this contribution as notable. Determination methodology EMMI and the task force considered four different calculation methodologies for the new repo index, and put the baseline methodology forward for consultation. Overall, the feedback received was supportive of EMMI s preferred option. Figure 1 Baseline and existing repo indices, December 2016 One respondent, however, considered that the proposed outlier assessment, coupled with the baseline methodology, would fail to eliminate Source: BrokerTec, Eurex Repo, MTS Repo, EMMI, and HSG calculations very specific 4 trades, distorting the index. EMMI would like to remark that in the design of the Stoxx GCP Rate RFR Euro Rate Baseline 4 Question number 12 in ICMA s FAQ on Repo provides an explanation on the meaning and use of specifics and specials. Page 8

9 methodology, we have taken the effect of specific trades in the resulting index into account and, contrary to the opinion of very specific trades distorting or biasing the index, believe that the index does encapsulate valuable and relevant information on the level at which repo transactions are being executed in the participating platforms (and hence the market). The behavior of the index at the end of 2016 is a good example of the index s responsiveness to market events: it provides a clear portrayal of the activity in the euro repo market, and information on whether the average repo transaction is being performed in search for cash or collateral. One respondent suggested the GC methodology as a better option for the index. Given the formulation of the underlying interest that the index seeks to measure (discussed in Section 2) and the analysis work we have undertaken, EMMI believes that the baseline methodology is a better reflection of the intended economic concept, as it does not restrict our attention to funding- or cash-driven transactions. Comments were also made on the common outlier assessment technique described in the consultation paper. In Section 5 of the consultation paper, point (v) in subsection a) mentioned that filtering is performed removing transactions with spreads greater than five, or with rates larger than 10%. These comments seem to originate from an unclear description of the outlier removal methodology: this is to be applied only to repo transactions with a positive rate. A couple of respondents showed interest in the publication, together with the pan-european index, of country indices. We identified significant heterogeneity in the repo market data contributed by BrokerTec, Eurex Repo, and MTS Repo, that indicate that a family of benchmarks, including country indices, could potentially be a solution to best represent the current composition of the euro repo market. EMMI s mission, however, is to foster the integration of the European financial market, and its existing indices and initiatives are living proof of these efforts ultimately, the heterogeneity challenge may only be solved or alleviated in the European political arena. Two respondents questioned EMMI s choice to remove bilateral and voice-brokered transactions. By sourcing the transactions from multilateral trading facilities (MTFs) and regulated markets (RMs), we believe that the index will be transparent and less prone to influence or manipulation. As mentioned in the consultation paper, BrokerTec, Eurex Repo, and MTS Repo operate trading facilities that are subject to the requirements and obligations of the MiFID framework. In the definition of the Governance Framework for the new repo index, EMMI will provide a full list of qualifying criteria that platforms will have to satisfy in order to contribute to the index. These criteria and other components of the methodology will be reviewed yearly by EMMI, as required by the EU Benchmarks Regulation. Page 9

10 Prospective use of the new repo index 4 Use of the new repo index in the discounting of EUR IRS In terms of use of the new repo benchmark the feedback was mixed. There was an overall praise of a secured benchmark being used, however there was trepidation regarding its potential to replace Eonia, should this scenario ever become necessary. Many respondents believed EMMI s pan-european repo index would be a viable substitute, however one respondent argued that an index must gain recognition and that any process focused on replacing existing benchmarks for alternatives would take a long time, and should be carefully analysed. Respondents on the whole believed trust, as well as transparency, robustness, and representativeness were key to the success of the new index. Respondents also indicated that, while the new repo index s initiative and proposal is a clear sign of EMMI s commitment to initiate the debate regarding the search for eligible and adequate alternative reference rates in the Eurozone, it is necessary that a group of market participants comes together and works toward analyzing, and ultimately identifying, possible alternatives and observe for which products the new repo index could be used. Feedback indicates that more involvement of European authorities would be necessary for such an initiative to succeed in Europe. Respondents highlighted the work done by the Working Group on Sterling Risk-Free Reference Rates (RFR), initiated by the of England, and the work of the Alternative Reference Rates Committee (ARRC), convened by the Federal Reserve of New York. 5 EMMI will continue its efforts towards the launch of the new repo index, while engaging parties involved in such an evolutionary process. 5 New repo index as a tool for transparency When asked if the new index would be a useful tool for transparency in the repo market, given the increasing reliance by market participants on secured money market transactions, the majority of respondents reacted positively, indicating that the index has the potential of providing a robust and transparent benchmark for the euro repo market. Some participants recommended the publication of further indicators together with the index. There was skepticism from one respondent as to whether the index was indeed necessary, and that the focus should be on improving Eonia and minimizing its shortcomings. EMMI believes the new repo index is an alternative to existing indices, and could be used for products that are currently referencing unsecured benchmarks: a fair amount of derivatives that are currently referencing unsecured indices could be indexed to a risk-free rate, based on a robust and liquid underlying market. 5 See the of England s site for more information on the Working Group on Sterling RFRs and the New York Fed s site for details on the work of the ARCC. Page 10

11 One respondent noted that the index shows a drop in volume at the end of the year, which does not indicate resilience and stability. The decrease in activity in the repo market at the end of the year is a wellknown and recognized phenomenon that does not pose any challenges to the use of the new index. By providing historical time series and statistics describing the behaviour of the proposed repo index, EMMI is approaching its implementation with transparency, allowing the market to understand how certain market events may have an impact. Another respondent suggested country sub-indices would be useful in providing additional transparency on the repo market. The issue was also raised that the pan-european repo index may only provide information about the electronically-traded repo market, rather than about the overall euro repo market. EMMI believes that these two issues have already been addressed in Section 3, under Determination Methodology. Page 11

12 Updated historical analysis 6 Data Analysis As in the June 2017 Consultation Paper, the data presented in this section have been derived from repo transactions executed in BrokerTec, Eurex Repo, and MTS Repo. On this occasion, and following some of the comments received in response to the consultation questions, EMMI has updated its analysis of the data underpinning the determination of the proposed new repo index in order to reflect a more current picture of the underlying market. In particular, the updated analysis captures the effect of the European Central s (ECB) expanded asset purchase programme (APP) up to and including December Figures 2 and 3 show the development of daily volume and market share for the three ATSs over time. The decreasing trend in Eurex s market share observed in the Consultation Paper continues, with a decrease of 12% in December 2015 to 5.3% in December In turn, the share of BrokerTec increased from 55.7% to 62%. Figure 2 Repo market volume across ATSs, monthly (EUR billion) Figure 3 Distribution of repo implied market share across ATSs, monthly BrokerTec Eurex MTS BrokerTec Eurex MTS 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% In line with the decrease of Eurex s activity is the decrease of GC repo trades observed in Figures 4 and 5. The impact of the ECB s monetary policy measures in the availability of collateral becomes apparent in these charts: the market for specific repos has increased from EUR 171 billion in December 2015 to EUR 203 billion in December More information on the Eurosystem s purchases of private sector securities and public sector securities can be found on the ECB s webpage. From March 2015 until March 2016, the Eurosystem made purchases under the APP at an average monthly pace of 60 billion, increasing to an average monthly pace of 80 billion from April 2016 until March From April 2017, the net asset purchases have continued at a monthly pace of 60 billion, with the intention of continuing at this level until the end of December 2017 (cf. monetary policy decisions of the Governing Council of the ECB of 9 March 2017). Page 12

13 Figure 4 GC and specific repo transactions volume, daily (EUR billion) Figure 5 GC and specific repo implied market share, daily GC Specific GC Specific 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% The evolution of the volume of market share for different one-day term types (namely, overnight, tomorrow-next, spot-next, and corporate-next) has not suffered a significant change (see Figures 6 and 7). Spot-next repos continue to be dominant, and their share has increased over the course of 2016 mainly at the expense of overnight repos, whose market share was of about 13% at the beginning of 2015 and in December 2016 represented about 5.3% of all repos. Figure 6 One-day repo volumes, daily (EUR billion) Figure 7 One-day repo volumes, implied share o/n t/n s/n c/n other o/n t/n s/n c/n other 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% The time-series evolution of the volume and market share of individual countries securities is shown in Figures 8 and 9. As a reminder of EMMI s classification: the charts show shares of the six most traded countries (Germany, Italy, France, Belgium, Spain, and the Netherlands), an EU category, and a residual one. EU repos include all GC repos on collateral baskets which include securities from more than one country (e.g. GC Pooling, GC, or European corporates), repos with European Investment and EFSF securities, or ISINs starting with the prefix XS as collateral. 7 The six main countries, together with the EU category, continue to dominate the euro repo market. The EU category follows a decreasing trend since March 2015, while Spanish collateral continued to gain market over the course of See Page 13

14 Figure 8 One-day repo volumes, daily (EUR billion) Figure 9 One-day repo volumes, implied share Germany France Italy Belgium Spain Netherlands EU Other 0 Germany France Italy Belgium Spain Netherlands EU Other 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 7 New repo index behavior Figure 10 Baseline index, Eonia, and ECB policy corridor, 2016 Figure 11 Baseline and Eonia indexes aggregated daily volumes, Depo MRO MLF Eonia Baseline EUR Billion Baseline Volume Eonia volume Jan 16 Apr 16 Jul 16 Oct 16 0 Jan 16 Apr 16 Jul 16 Oct 16 Source: BrokerTec, Eurex Repo, MTS Repo, EMMI, and HSG calculations Figure 12 Baseline, Stoxx GCP, and RFR Euro indexes, Stoxx GCP Rate RFR Euro Rate Baseline Jan 16 Feb 16 Mar 16 Apr 16 May 16 Jun 16 Jul 16 Aug 16 Sep 16 Oct 16 Nov 16 Dec 16 Source: BrokerTec, Eurex Repo, MTS Repo, ECB, and HSG calculations Page 14

15 List of respondents The (EMMI) thanks all consultation respondents for their feedback on EMMI s proposal for a pan-european transaction-based repo benchmark. EMMI received responses from thirty-two (32) organizations, listed below. Organization AEFMA, Technical Committee on Repo/Lending/Collateral Amundi Asociación Española de Banca (AEB) AXA Investment Managers Banca Monte dei Paschi di Siena Banco BPI ia BBVA BNP Paribas Fortis Belfius Bundesverband Öffentlicher en Deutschlands (VÖB) Caja Rural Cecabank Commerzbank Crédit Agricole Danske DZ European Fund and Asset Management Association (EFAMA) European Savings and Retail ing Group (ESBG) KBC NV Intercontinental Exchange (ICE) Instytut Badań nad Gospodarką Rynkową (IBnGR) ING Intesa Sanpaolo Landesbank Baden-Württenberg Natixis Novo Banco Banco Santander Swiss Reinsurance Company (Swiss Re) Unicredit AG Union Investment Privatfonds GmbH Sector Association Asset Management Association Asset Management Association Association Association Exchange Academic Institution Insurance Asset Management Page 15