FICC Proposes Expanding Eligible Collateral for GCF Repo Service
To broaden borrowing options for its customers at a time when demand is strong to tap new sources of liquidity, DTCC’s Fixed Income Clearing Corporation (FICC) is looking to expand – possibly by early next year – the type of collateral eligible for transactions in its General Collateral Finance Repurchase (GCF Repo®) Agreement service.
Under consideration as additional collateral types for GCF Repos are the real estate mortgage investment conduits (REMICs) issued by federal government-sponsored enterprises such as Fannie Mae. Also under review are corporate bonds and equities.
“We’re working with individuals throughout the industry as well as SIFMA [Securities Industry and Financial Markets Association] to gauge the level of interest in and degree of urgency there might be for this kind of collateral expansion,” said Murray Pozmanter, DTCC managing director, Clearance and Settlement Product Management.
Popular financing method
Since their introduction in 1998, GCF Repos have been widely used for short-term financing because they can be traded throughout the day without requiring the allocation of collateral or cash payment for each transaction until the end of the day – when all the trades are netted.
Since there is no need for the delivery of securities in exchange for payment for every transaction, GCF Repos provide particular flexibility for tri-party arrangements where a third party can “match” the two parties in a transaction, and then takes over the responsibility for collateralizing and administering the repo agreement.
Rising volume
In May, after a five-year hiatus, FICC reinstated the GCF Repo service for transactions between customers who settle at different settlement banks – either Bank of New York Mellon or JPMorgan Chase. Until then, restrictions prevented brokers from executing GCF Repos with their customers unless both sides of the transaction could settle at the same settling bank.
Since the reopening of the inter-bank market, the volume of GCF Repo trading has climbed nearly 45%, rising from a daily average of $507.4 billion in par value during the first four months of the year to an average of $735.3 billion a day since the reestablishment of inter-bank transactions. Following the netting process by FICC’s Government Securities Division, the average daily inter-bank settlement is about $23 billion. (See Volumes and Values for Fixed Income Securities Remain At Record Levels)
Current collateral types
Collateral that FICC currently accepts for GCF Repos includes three categories:
- U.S. Treasury bills, bonds and notes;
- Fixed and adjustable-rate mortgage-backed securities issued by Fannie Mae, Ginnie Mae and Freddie Mac; and
- Non-mortgage-backed securities issued by government-sponsored enterprises such as Sallie Mae, which provides student loans, and local transit agencies.
This collateral is also more or less interchangeable within each category. For example, when a party to a 30-day GCF Repo reallocates its collateral each day, it doesn’t have to put up the exact same securities. It can submit almost any collateral within that accepted category as long as it represents roughly the same value.
Widening the pool
Expanding the collateral acceptable for GCF Repos, Pozmanter said, will make the instrument an even more flexible financial tool and broaden the base of users.
“Our aim is to expand liquidity, not only by re-instituting the inter-bank market for GCF Repos, which makes trading more flexible, but also by making additional financial products acceptable as collateral. This should allow firms to leverage expanded liquidity against a greater portion of their assets,” he said.
REMICs, which are backed by cash flows from mortgage-backed securities or residential mortgage loans, are set up as a way to divide interest and principal payments into separately traded securities. Agency-issued REMICs, both fixed-rate and those known in industry parlance as “floaters,” which can undergo monthly rate changes, are being reviewed for inclusion as collateral.
Corporate debt and equity eligibility
How corporate bonds might be applied as collateral is still under review, according to Lisa Meiselman, DTCC director, Clearance and Settlement, Product Management. “Whether we aggregate highly rated corporate bonds as one type of collateral and investment-grade bonds with a lower rating as another type is still up in the air,” she said. “This is where we can be guided by industry practices.” No matter which rating a bond has, however, Meiselman said parties to a GCF Repo could not pledge their own corporate bonds as collateral.
As with corporate bonds, firms would likewise be precluded from pledging their own equity shares as collateral. Using equities as collateral also raises procedural questions.
“If we make equities eligible as collateral and they are pledged, we will need to determine whether this constitutes a repo transaction or falls under the established rules of securities lending,” Meiselman said.
Sorting out these questions, getting regulatory approval for the additional collateral types and revamping FICC’s own value-at-risk methodology to accommodate the new instruments is expected to take a number of months until completion. @