Central clearing for repo markets: Is Europe putting the cart before the horse?

The European government bond repo market has a basic but important mission — to get cash and collateral from those who have it to those who need it in a timely manner, with stable pricing which is reflective of a liquid, transparent, and functional market with minimal frictions. Nevertheless, even seasoned participants will admit that the market continues to surprise, and it is rare for a month to pass without observing something new. The past decade has seen a number of different repo market regime changes, driven by regulatory constraints since the post-global financial crisis regulatory reforms, and central bank interventions for liquidity support, price stability or crisis management. Established relationships between repo market variables have been known to temporarily or even permanently decouple, and more extreme dislocations have also been observed in the European market and are arguably growing in frequency.It is the latter point that has key stakeholders in the European repo market asking more fundamental questions about the most optimal market structure. From the large Dutch pension funds which need to place billions in cash overnight, to international global systemically important banks (G-SIBs) managing their cross-border exposure, to central banks trying to estimate reserves demand — it seems everyone has their angle.Central clearingIn late 2023, the US Securities and Exchange Commission (SEC) adopted a central clearing mandate for US Treasury repo (and cash) to address ongoing dysfunction in a market which underpins the financial system. While the proposal had been flagged for some time, the decision was still curious given the range of policy alternatives available and the low base from which the mandate would be imposed (20-30 per cent of US Treasury repo was centrally cleared). The Bank of England have highlighted that repo will be integral to their operating framework for winding down extraordinary monetary policy operations towards a steady state. While no announcement has been made on a clearing mandate, the Bank has published extensively on the impact of broader central clearing on the gilt repo market, leading to growing speculation that the UK may follow the US lead. In Europe, a similar debate is gaining momentum, albeit from a very different starting point. Unlike the US and UK, the European government bond repo market is heterogeneous in terms of domestic issuers and fragmented in terms of trading, clearing, and settlement infrastructure. One could be forgiven for assuming that central counterparties (CCPs) are behind the push for a mandate in Europe, but such assumptions are without foundation. CCPs such as Eurex are cross-asset market infrastructures and recognize that even small policy tweaks to the repo market have potential for material second order impacts to other asset classes. We are also acutely aware that with regulatory mandates, market participants have substantial development and implementation costs and divert scarce resources from new product initiatives and market innovations.Nevertheless, would mandatory central clearing for the European repo market be the worst thing in the world? At the GFF Summit 2025 in Luxembourg, there was a broad consensus from a number of panels that central clearing was a good thing, and that the European repo market would benefit from an expansion of central clearing. Central clearing brings an extensive list of benefits to financial markets, but the capability for multilateral netting for risk, settlement, and accounting purposes gives CCPs a unique position in the repo market, and actually creates capacity for more bank intermediation.While the debate will be fierce, one thing all stakeholders can agree on is that the decision for Europe should be focused on solving European market structure or monetary policy transmission challenges and be cognizant of European specificities, as opposed to blindly following the lead of other jurisdictions. Therefore, we have chosen to focus our contribution on some of the barriers Eurex and our industry partners from the buy and sell side have faced in building a more robust cleared repo market structure for cash and collateral-driven markets. Unsurprisingly, most of the barriers relate to the regulatory frameworks for non-bank financial institutions (NBFIs) and the interaction of NBFIs with the banking regulatory framework.The complex interplay between bank prudential regulation and accounting standards requires that the market design involves NBFIs becoming direct members of CCPs for the market efficiencies to be realized. Innovative clearing models have been designed for this purpose. However, the design of the relevant NBFI regulatory frameworks never envisaged more direct participation in centrally cleared repo markets. Eurex recently published a discussion paper, ‘Central clearing of repo markets in Europe – lift the barriers and watch the market evolve’, and we highlight some of the key elements here:NBFI regulatory frameworks should be adapted for a centrally cleared landscapeMoney market funds are a core component of the market structure for centrally cleared repo in the US but are a missing piece of the puzzle in Europe. Notwithstanding the significant differences in size of assets under management in the US versus Europe, this can partly be attributed to constraining regulatory elements which do not align with a centrally cleared repo market landscape. For instance, counterparty limits for funds mitigate concentration risks when a fund builds up exposure towards a counterparty. In a centrally cleared landscape, the CCP automatically becomes the counterparty to the transaction, so the fund will test the counterparty limit a lot quicker than when the fund uses the bilateral market facing multiple counterparties.In addition, regulation does not allow funds to re-use cash or collateral (including via pledge) generated on repo markets to meet margin requirements at CCPs. The consequence is that funds need to find other resources to meet those obligations.In respect of insurance companies, European Insurance and Occupational Pensions Authority (EIOPA) recently recommended that Solvency II should be adapted to afford preferential capital treatment where the firm directly faces a CCP for derivative transactions, in alignment with banking regulation. However, the preferential treatment was not extended to include repos on recommendation, or weak support, from the industry’s trade associations. We would encourage these stakeholders to revisit their position, given that the provisions do not compel insurance firms to centrally clear repos, and the preferential capital treatment would improve the economics for those firms who choose to clear.Risk standards between bilateral and centrally cleared markets should be alignedIn Eurex’s efforts to develop centrally cleared repo markets, the disparity in risk standards when compared to bilateral is one of the major hurdles.Centrally cleared repo transactions are subject to margin requirements and standards for acceptable margin collateral. Those requirements are calibrated against: minimum regulatory standards; the risk management expectations of the CCP’s members based on their ‘skin in the game’; and the CCP’s own ‘skin in the game’. Robust, risk-appropriate margining and risk management practices, including intraday margin calls, are a feature of central clearing, not a bug.In contrast, market participants enjoy contractual freedom in the setting of haircuts or margin, and the risk management practices for bilateral repo transactions. A number of working papers by central banks and policy institutes have highlighted that “the bulk of” bilateral repo transactions in Europe have no haircut on the collateral.Alignment of risk management standards across bilateral and centrally cleared repo markets remains one of the most challenging prudential regulation problems to be solved, especially in view of the risks of outsized leverage in the NBFI sector. The Financial Stability Board’s (FSB’s) now defunct ‘Mandatory haircuts for non-centrally cleared SFTs’ proposals were very much a case study in ‘regulating for the last crisis’. The scope and design were never going to be comprehensive enough to address the bilateral versus centrally cleared disparity, nor some of the risk management failures that have materialized since the measures were initially proposed.The problem needs some fresh thinking and new proposals should consider a holistic view of the financial system, particularly as the consequences of miscalibrated policy measures on the smooth functioning of markets are high. In the interim, and perhaps as an alternative, we are strongly of the view that robust prudential supervision can play a productive role in achieving the desired improved alignment. While it is naive to expect fully aligned risk management standards between bilateral and centrally cleared repo markets, a blanket practice of zero haircuts in bilateral markets should not go unchallenged.Innovation and efficiencies should be promoted, notably cross product netting and marginingThe cash, repo, and derivative markets for government bonds and interest rate benchmarks are inextricably linked. Market participants are active in trading the basis between the cash and derivative segments, and repo markets facilitate basis trading through funding and financing of the positions and accordingly enter the trading calculus.While positions are taken in the different product segments, they are based on the same or highly correlated underliers, such that the net market risk is minimized or even fully flat. Basing margins on the net risk position across product segments can deliver material cost efficiencies, and these practices have long been applied by banks to support their clients, particularly in the prime brokerage channel.Cross-asset CCPs also offer this capability based on the portfolio theory above, but most importantly based on the robust CCP legal framework and default management processes to close out positions across product segments in an efficient and timely manner. The availability of cross-product margining would help mitigate the margin disparity challenges for NBFI adoption outlined earlier, subject to the margin outcomes remaining risk-appropriate.While the Basel capital framework for banks recognizes the legality of cross-product netting agreements, the standardized approaches applied for the calculation of credit exposure treat repo and derivatives as standalone, independent calculations with no capability to recognize risk offsets across these segments. This disincentivizes banks from offering CCP cross-product margining services to their NBFI clients.A number of industry stakeholders (e.g. trade associations, academia) have offered methodology alternatives to address this shortcoming. It is imperative that global regulators prioritize the review of these alternatives so that the efficiencies from cross-product margining at CCPs can be realized and capital can be unlocked.A favorable treatment of centrally cleared repo under the NSFR should be consideredThe net stable funding ratio (NSFR) aims to minimize rollover risks by encouraging banks to fund their assets with more stable sources.Under the NSFR framework, CCPs are treated just like any other financial institution. But most importantly, cleared repo receives no preferential stable funding treatment even though cleared repo markets have proved to be remarkably resilient under stressed market conditions. There are even instances under the framework where the favorable stable funding treatment afforded to banks from particular counterparties (e.g. public sector, corporates) is lost if the repo is centrally cleared. This disincentivizes banks from centrally clearing repo trades with these counterparties, and hinders the development of a broader, robust market structure.We recommend that the NSFR framework be revisited to improve recognition of the stable funding benefits of centrally cleared repo, and prioritize the removal of elements which inadvertently disincentivize central clearing.Voluntary clearing by the public sector should be incentivizedWhile there is already a growing number of public sector entities joining central clearing voluntarily, a higher participation rate would deepen the European ecosystem and create a pull factor for other market participants.The participation of central banks, in particular, would provide a crisis-proof liquidity management mechanism for NBFIs.Final thoughtsWhile the US is moving forward with mandatory central clearing for US Treasury repo transactions, the appropriateness of such a policy for Europe, with its heterogeneous government bond market and fragmented market infrastructure, remains an open question.Notwithstanding, the benefits of central clearing to market structure and financial stability are clear and our position is that there is a lot that can be done to remove the barriers to market-driven adoption of centrally-cleared repo before having to resort to the ‘stick’ of a mandate. Even though these structural barriers would need to be addressed even more urgently if a mandate was to be adopted, Europe may not want to put the cart before the horse.Weiter zum vollständigen Artikel bei Deutsche Boerse AG Unsponsored American Deposit Weiter zum vollständigen Artikel bei Deutsche Boerse AG Unsponsored American Deposit