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The work of the MMLG Cleared Term DBV Sub-Group Presentation to the ISLA Operations

The work of the MMLG Cleared Term DBV Sub-Group Presentation to the ISLA Operations Group Annual Conference 25 October 2013. AGENDA. The issue and case for change Background Risks with current DBV mechanism Term DBV The MMLG Cleared TDBV Sub-Group Objective Progress to date

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The work of the MMLG Cleared Term DBV Sub-Group Presentation to the ISLA Operations

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  1. The work of the MMLG Cleared Term DBV Sub-Group Presentation to the ISLA Operations Group Annual Conference 25 October 2013

  2. AGENDA • The issue and case for change • Background • Risks with current DBV mechanism • Term DBV • The MMLG Cleared TDBV Sub-Group • Objective • Progress to date • The Term DBV product • Questions

  3. The issue and case for change Michael Jones Market Services Division

  4. Growth in the Market...

  5. ...secured flows now dwarf unsecured Average daily turnover in sterling money market (Nov 2012)

  6. Term DBV volumes: the only way is up!

  7. The Bank’s front office interests • Broad interest in stability of the market: key transmission channel for monetary policy • DBV central to Bank’s own operations: • Peak daily value during crisis = £85bn • From July 2011, Bank counterparties have had option of using Term DBV in Operations... • ...and we made it clear that we were ‘minded to discontinue use of Rolling Overnight DBV’ • MMLG oversight

  8. Current DBV mechanism • The DBV mechanism in CREST is central to GC collateral delivery in the UK market • Current overnight DBV model is tried-and-tested • low cost easy way of delivering market-defined baskets of GC • no substitutions or mark-to-market needed because collateral is returned every morning • reliable • But it masks hidden issues • an inefficient and risky churn of daily return and reissue • dependency on provision of central bank liquidity through auto collateralised repo to fund intraday positions

  9. Risks • In the event of a counterparty or system-wide outage intraday between morning unwind and afternoon re-input: • DBV counterparties would be left holding the ‘wrong’ asset • counterparties would be required to manage liquidity dislocation • DBV counterparties and their CREST settlement banks would be left with credit exposures • the Bank would be left with intra-day liquidity extension to settlement banks that might need to be converted into overnight facilities • The values are substantial

  10. 11 November 2011 • Severe SWIFT outage on 11 November 2011 meant many of the day’s DBVs (including LCH’s) could not be submitted until very late in the day • DBV value input after the outage was resolved was £159bn • Outstanding IDL (a large proportion of which is normally repaid automatically in afternoon DBVs) was at £82bn at the point of failure

  11. The challenge • The Bank has been exercised by the risks for many years • Objective is to align the settlement arrangements with the underlying economic terms of the repo • not to change the fundamental form of the trade • The challenge is to reduce risks while retaining the benefits of the DBV basket collateral mechanism. • The Term DBV product in CREST offers a solution

  12. Benefits • From reduction in daily cash and collateral settlement flow • in aggregate, less credit needed for settlement • reduced position management ahead of DBV settlement window • reduced reliance on central bank liquidity provision • Tail risk • reduced risk from operational interruption • only overnight and new business exposed to intraday interruption • reduced potential dislocation of liquidity

  13. MMLG Cleared TDBV Sub-Group Michael Jones Market Services Division

  14. Genesis • Recognition in the market of the issue – LMMA catalyst • Complex change – need for a group to oversee the work • MMLG Sub-group formed includes representatives from EUI, CREST, LMMA, DMO, ISLA, Bank of England, major repo trading banks • Focus today is LCH introduction of a cleared Term GC product • TDBV could not gain sufficient traction without being cleared through LCH.C which accounts for ~40% of DBV value settled • But also keen to encourage ‘bi-lateral’ use of TDBV

  15. Aims and Progress • End objective is a smooth market adoption of a cleared TDBV product that is fit for purpose • Steering group facilitates discussion and resolution of key issues and coordinates the delivery process and adoption activity • Four key strands of work • Product design – now complete and delivery being monitored • Market ‘good practice’ – close to final • Market adoption – now the focus • Wider adoption of TDBV – previous discussion with ISLA

  16. What next? • IT delivery and testing • Monitoring of market preparedness • Agreement of migration approach • Communications with market • Delivery expected in Q3 2014 • Explore bi-lateral use further

  17. Term DBVISLA Operations Group Annual Conference25 October 2013

  18. Term DBV - introduction • Term DBV introduced in June 2011 • Using standard DBV components • Using an agreed ‘basket’ of securities • 70 minute window post DVP settlement (3pm) • Key requirements: • Reduce systemic risk(associated with large intraday SCR generation) • Reduce operational risk • Minimise intraday credit requirements • Minimise intraday cash exposure

  19. Key Features • Input and selection • Uses existing DBV algorithm (standard baskets) • Return date (1 day – 2 years) • Mark to Market • Overnight valuation – for next day settlement • Substitutions (Eligibility & Giver Recall) • Automatic recall based on Corporate Action or settlement need • Delivery versus delivery • Adjustments • Ability to adjust DBV to match collateral requirements • Interest Calculation • Interest accrued daily for length of term (TDI)

  20. Cleared Term DBV roll out • Final timetable to be confirmed • CREST system changes planned for March 2014 followed by LCH.C in the second half of 2014 • Migration: • LCH.C migration plans – roll off use of Sterling GC 90 days after launch of Term Sterling GC • EUI enhancements – in addition to changes to support LCH.C • Facilitate Substitutions during DBV settlement • Continuous real-time substitutions and mark to markets • DVP available alongside DBV settlement – major architectural change • Support negative interest rates (hopefully never used for Sterling)

  21. Bilateral Term DBVs • Supports equity and fixed income • Intraday funding requirement removed (non SCR securities) • Remain fully collateralised for duration of repo • No intraday cash exposure • Concentration limits • Up to 99 securities per delivery • Term 1 day – replicates overnight • Overnight DBV – future support ?

  22. Questions?

  23. The work of the MMLG Cleared Term DBV Sub-Group Presentation to the ISLA Operations Group Annual Conference 25 October 2013

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