LCH Set to Offer Repo Client Clearing Service
LCH recently announced that they will launch a client clearing service for repo trades. This is good news for banks as it will ease the balance sheet impact of repo trades with buy-side firms.
Buy-side firms will now be able to clear their repo trades through the RepoClear service by using a bank as their clearing member. The buy-side client will not be able to access the RepoClear service directly, as the LCH needs to ensure that it is only ever facing exposure to approved Clearing Members (which are generally banks).
Repo transactions have gained popularity and have increased in volume since the regulatory requirement to post collateral for cleared and uncleared derivatives transactions was imposed. Repo offers a low risk way of backing in the collateral you need, by utilizing the assets you have on your balance sheet. However, to date, repo costs have been higher than usual due to the leveraged ratio which regulation has imposed on banks and which requires them to incur capital charges on exposures.
Currently, repo exposures are calculated on the gross notional amount with netting of exposure only permitted against off-setting trades with the same counterparty. However, if one is able to clear repo transactions through a central counterparty, or CCP (like LCH), then the exposures will be able to be calculated net across all off-setting trades done through that CCP. This will in turn reduce the cost of repo transactions.
That being said, this will obviously only work efficiently if there are off-setting trades at the CCP. Some are of the opinion that most cleared repo trades are directional and thus won’t be able to be netted. Some are also skeptical that the costs of this clearing service may be too great for the relatively small number of repo trades that will be cleared (compared to the volumes of derivatives trades which are cleared). Time will tell whether clearing repo trades will be a financially viable business solution that banks can offer to their clients or not.
To read another related DeriviDoc blog post, click here: Should Securities Lending Transactions be Cleared?
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