GC Friday Interview: Mark Gem of Clearstream on Interoperability

The International Capital Markets Association’s European Repo Council has signed a memorandum of understanding (MoU) which engages Clearstream, Eurex Clearing and Euroclear providers in a joint project enabling their systems to work together to increase the efficiency of the repo market. The project primarily creates the opportunity for Eurex Clearing to extend the connected settlement locations for its secured funding market GC Pooling with Clearstream Banking to include Euroclear Bank. Mark Gem, head of business management, Clearstream explains why the market is opening up

Why did you sign an MoU?

MG: The subject of an MOU has been around for a number of years. Since the time of the financial crisis there has been a growing level of interest on the part of the market in triparty settlement interoperability.

Indeed if we look at the trading of collateral baskets and the clearing of settlement baskets in Europe on the books of the German CSD then we can see that volume picked up quite spectacularly after the crisis, not surprisingly perhaps because it was a very attractive funding route to banks for all sorts of reasons and as the market sought to collateralize its money market exposures this was an efficient way of doing so quickly. Clearly the starting point was that Eurex, for safety considerations, had said that product must settle in the books of the German domestic CSD, the point being that CSD settlement should work in central bank money so in essence they wanted to see this settled in the Bundesbank on the cash side. That was fine in the pre-crisis side of the product but obviously as the volumes grew the benefits this could give those people who prefer to work in the ICSD environment, commercial money environment, also developed a strong interest in being able to access that directly and we started to discuss that seriously 2009/2010. In that time frame it became clear under what conditions Europe could open this up to the ICSDs and ourselves at Clearstream in Luxembourg and Euroclear Bank in Brussels.

From our perspective the key points were twofold: one, how is that done, but also if you open it up to the international settlement market infrastructure being Euroclear and Clearstream and the interoperability they already maintain with the German market then how do we ensure that that settlement infrastructure is brought up to the standard that is necessary to support the product, how do we make sure the individual repo systems of Clearstream as an ICSD and Euroclear bank as an ICSD are also adapted into that market. So these are the variables. What has happened is that the MoU is an in principal agreement to do all of those things. So we can extend the offering of commercial bank money settlement at Clearstream in Luxembourg and Euroclear in Belgium.

When designing the product originally, Eurex Repo had required settlement in central bank money, which is not an unusual behavior for domestic CCPs. When it comes to infrastructure matters we have to co-operate and have solutions for the market and that from our point of view is what had happened.

What about CCP interoperability? EACH said it had abandoned a project to achieve this so what has changed?

MG: We can’t speak for the CCPs, but from Clearstream’s point of view when it comes to settlement infrastructure the more interoperability the more harmonization the better. We’ve always promoted strong links between the CSDs and that’s whey we favor T2S and it therefore not surprising that we’ve welcomed a development such as the MoU signing from our own perspective and are very enthusiastic about it.

What does improving settlement interoperability mean in practice?

MG: What that means in practice is that settlement deadlines and opportunities between the two ICSD must be reviewed and enhanced so that interoperability can be a success. That’s a responsibility that falls on us and its one that we take seriously and I am absolutely confident that our colleagues at Euroclear take seriously as well. We need to increase the frequency with which our prospective customers can settlement with each other during the day time settlement period, basically increasing the frequency by a factor of 2-4 and secondly be able to facilitate the later processing of instructions, particularly for liquidity management purchases. That’s where a product like this is so useful. You can move the collateral late in the day in order to finalize your funding arrangement. It’s a couple of relatively straightforward improvements and enhancements to the bridge that the ICSDs are agreeing in principle to make as a result of the MoU.

For that we have a clear benchmark we need to support the three settlement locations for the GC pooling benchmark and the CSDs that would want to use it in the future. The reason to improve that and the benchmark to improve that is that the interoperability of the ICSD for settlement must be brought to a level to at least the equivalent to the one we have as an ICSD to the best CSD in Europe, which in this case is the T2S environment and in future improve them at the same level the interoperability with the ICSD we will have with T2S. Between the two ICSDs the interoperability we currently have is below that standard. We need to raise it to least above that to be able to offer it in the settlement location of T2S, Euroclear Bank and Clearstream.

How will the Financial Transactions Tax (FTT) affect this interoperability?

MG: At one level if you apply what the Commission says about the repo markets there won’t be any repo market. Doing the maths on this and a straight line on Clearstream’s current volumes the average settlement in our books would attract something like EUR 6000 of tax per transaction. If you imagine somebody was funding themselves overnight on a repo basis at today’s interest rates they’d be paying a little over a quarter percent based on their credit rating of counterparty risk. If you applied these 10 bps proposed by the FTT to each trade then theoretically the costs of funding yourself overnight at that rate would raise to 39% per trade a which means you would rather do it unsecured whoever you were. In some cases the sheer scale of the proposals mean we don’t really need to be too worried.