Deutsche BörseGlobal Funding and Financing SummitCollateral, the force that binds us...&&Farewell 2016…. Welcome 2017

26 January 2017Michael Manna, Head of Fixed Income Financing Trading, EMEA & Asia

Themes

Setting the Scene

Regulation: Catalyst for new Relationships and Reliance on Repo

Collateral: What matters Cost or Quantum?Collateral: What matters - Cost or Quantum?

The Repo Desk: View from a Commercial Lens

European Repo Market: Depth, Breadth and Rigidity

Farewell 2016…. Welcome 2017

1

Setting the Scene……g

Then Now

Light Touch Regulation Prescriptive Regulation

Simple System Complex System

Light Touch Regulation Prescriptive Regulation

C di i l TB d T

No Shortage of Collateral Debate about a Possible Shortage of Collateral

Conditional TrustBased on Trust

Abundance of Liquidity Questioning Liquidity

Capital is Ample Capital is Never Enough

“….the public perception of liquidity changed, from one based on assets (what you could sell) to one centred on

Liabilities (ease of borrowing)”(1)

Has the public perception of liquidity changed back to one based “on assets (what you could sell)” vs one “centered

on Liabilities (ease of borrowing)”?(1)

Something to think about….. Could also be akin to a monetary system moving from a ‘Gold

Something to think about….. If so is the financial landscape gravitating away from oneCould also be akin to a monetary system moving from a Gold

Standard’ to a ‘Fiat Standard’? If so, is the financial landscape gravitating away from one

based on a ‘Fiat Currency’ and towards one based on a ‘Gold Standard’, underpinned by collateral?

___________________________1. A speech by Lionel Barber, Financial Times editor, at Hughes Hall, University of Cambridge, May 1, 2014.

2

Regulation: Catalyst for new Relationships and Reliance on Repo

Regulation: Catalyst for New Relationshipsg y p

Regulations and Improved Risk Mgmt places a focus on….

Counterparty Risk

There is now an incentive to reduce risk therefore collateralise exposure

Leads to an increased demand forUNECUMBERED high quality collateral

Stimulates connections in the financial system between Regulation has defined High Quality Collateral

Banks & Non-Banks Financial Markets & the Sovereign

Requires Cash Market Li idit

Sovereign Collateral is the largest Type

Low Volatility & Highly Rated by agencies

Relies on a Repo Market with depth and breadth

Leads to a need for more capital (balance sheet) to

Stable Governments with Prudent fiscal policies

Liquidity

Prudent fiscal policy results in

a smaller supply of

ll t l

Supported by a liquid repo market

support demandp collateral

Whilst simultaneously availability is contracting

3

Mandatory Swap Clearing: Catalyst for New Connectionsy p g yDodd-Frank and EMIR rules have created a requirement for banks and certain non-banks to centrally clear swaps activity. This has lead

to an increased need for both; initial and variable margin. This presents a real challenge for non-banks given how different this is to past practices.

CCPCCPClearingClearing Initial Margin (IM)

IR Swap

Cash or Securities

CCPCCPg

Bank (A)

gBank (A)

Non-BankNon-BankVariable Margin (VM) Initial Margin (IM)

Cash

VMVM Passes to the swap

counterparty

IM Remains with the CCP and becomes part of the

Assuming the pension fund has the right type of collateral in its portfolio to meet IM requirements,what options are available for meeting VM requirements?

default waterfall

Fund no longer uses derivatives

Hold a cash buffer – stay underinvested

Sell securities to meet VM margin calls

1

2

3

Stay fully invested, don’t sell any securities and borrow the funds, A.K.A perform “collateral transformation” / convert securities into Cash4

Choosing the 4th option is the catalyst for a new connection……Choosing the 4th option is the catalyst for a new connection……

4

Mandatory Swap Clearing:Two New Connections – Two Different Reasons

The preferred method for obtaining secure funding is through the repo market, Securities converted to cash, “Collateral Transformation”, in other words physical leverage. The requirement for funding and collateralisation creates two new connections: (1)

Bank and non-Banks, (2) CCP and Banks. Two different objectives both linked via the Repo market. In addition, this new demand creates a requirement to commit financial resources, i.e. balance sheet, to support this activity.

Cl iCl iIR Swap

B kB kCCPCCP

ClearingBank (A)

ClearingBank (A)

Non-BankNon-BankVM

ash

ater

al

IM (Securities)BankSwap

Counterparty

BankSwap

Counterparty

IM (Cash)

Cash IM

Ca

Col

la

CollateralBankBankTri partyTri party

12

Cash

BankB

BankB

Tri party systemTri party system

Collateral

Classical Collateral Transformation in Reverse

New demand from CCPs transforms cash to collateral in order to segregate the IM.

This collateral is not re-used; it becomes encumbered & thus loses “velocity”

5

Mandatory Swap Clearing:Participation Grows, Requirements Expand, Connections Increase – the System becomes more Complexy p

As central cleared swap volumes and/or volatility increase the requirement for transforming; securities into cash, cash into collateral and in some cases ineligible collateral into good collateral will also increase. Naturally, connectivity between banks, non-banks and the

CCPs will also increase. All these activities will also place an increased demand on banks balance sheet. The Basel 3 leverage ratio limits how much leverage one bank can facilitate for non-banks forcing them to diversify counterparties creating more connections.

LCH & CME Total Initial Margin Requirement (£ Bln)(1)

CCPCCP

Credit/Equity Collateral

GBank CBank C

“Good” Collateral is released

Requirement (£,Bln)(1)

Swap

Gov’t BondCollateral

Gov

’t bo

ndco

llate

ral

Credit/Equity C

ollateral

160

180

200

Bln

Non-Bank(Pension)Non-Bank(Pension)

Non-Bank(Pension)Non-Bank(Pension)

Clearing Bank (A)Clearing Bank (A)

IM C

ash

VM Cash

h BC

oral

IMp

Non-BankNon-Bank

Re-investmentRe-investment

Tri-partyTri-party

CashSecurity LendingSecurity Lending

Col

late

ral

80

100

120

140

160

VM C

as

Bonds

ollateralCol

late

r

B k BB k B

Cas

h

Bonds

MMk FundsMMk Funds

Cash

Tri Party

Tri Party

Cash0

20

40

60

Sep-15 Dec-15 Mar-16 Jun-16

___________________________1. Source: CPMI IOSCO Quantitative Disclosure from LCH and CME.

Collateral Bank B Bank B Party SystemParty

System

Collateral

http://www.lch.com/rules-regulations/regulatory-responseshttp://www.cmegroup.com/clearing/cpmi-iosco-reporting.html

6

Uncleared Derivatives Margin: Existing Connection,Demand for Collateral Increases – Velocity DecreasesyIn September 2013 the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions

(IOSCO) jointly published a final framework establishing consistent global standards for margin requirements fornon-centrally-cleared derivatives.

The rules require one way VM posting but two way IM collateral posting. An important aspect is the fact that the collateral will be t d d t b d Thi ill h l ti ff t it il bilit d isegregated and cannot be re-used. This will have a lasting effect on its availability and price.

Bank T

Bank T

Balance Sheet Allocation

VM Cash

CCPCCPMandatory Central

ClearingBank

SwapsBank

Swaps

TreasuryTreasury VM Cash

IM Cash

Balance Sheet Allocation

IM Bond

VM Cash

Balance Sheet Transfer

BankCounterparty

Swaps Desk

Swaps Desk

Repo /Collateral Mgmt

Repo /Collateral Mgmt

CashBond

VM Cash

3rd party Segregated IMRequirement

Cas

h

Bon

dPu

rcha

ses

or b

orro

ws IM Bonds IM Bonds

External or Internal Sources

Mandatory non-cleared OTC IMBusinesses will gain a benefit though reduced capital requirements (RWA) but will be

introduced to new costs and the relationship between collateral and balance sheet, which unless they can increase revenue, will have a drag on their RoE

7

New Connections: I Have Cash, need Collateral….Monetary policy has created a large amount of excess bank reserves and at the same time non-bank cash reserves have grown. Regulation clearly defines what constitutes regulatory compliant liquidity. Some institutions are comfortable to commit to term

deposits but most are looking for a short term option (<1 month) to place their cash. Unfortunately as bank balance sheets shrink and they improve their funding composition to meet new standards, short term deposits become not only unattractive but also costly with

regards to returns on leverage balance sheet This forces cash rich non banks to seek alternative options

,

regards to returns on leverage balance sheet. This forces cash rich non-banks to seek alternative options.

Money Market

A US specific flow,Money Market Funds

have access to the FED Collateral

Dampens collateral“velocity”

Non regulatory compliant li idit

Money MarketFund via the RRP Creating a

connection between the Central Bank & Non-banks linked by repo

Banks have a natural advantage over non-banks given they have access to central bank deposit facilities, providing a home for

excess bank reserves but leavingUns

ecur

ed

Dep

osits

Non-Banks Central BankBank

liquidity excess bank reserves but leaving non-banks scrambling for options

U

Liability Asset

LeverageLeverage

Recent BoE policy decision

seeks to address

BankTri party systemTri party system

Collateral

Collateral

seeks to address this issue

8

New Connections: I Have Cash, need Collateral….,

% Cash Levels Held by Asset Managers (Non-MMK Funds)(1) On-Shore US Money Fund Assets ($Bln)(3)

14

16900

1,000

4

6

8

10

12

14

200300400500600700800

0

2

Jan-

00A

ug-0

0M

ar-0

1O

ct-0

1M

ay-0

2D

ec-0

2Ju

l-03

Feb-

04S

ep-0

4A

pr-0

5N

ov-0

5Ju

n-06

Jan-

07A

ug-0

7M

ar-0

8O

ct-0

8M

ay-0

9D

ec-0

9Ju

l-10

Feb-

11S

ep-1

1A

pr-1

2N

ov-1

2Ju

n-13

Jan-

14A

ug-1

4M

ar-1

5O

ct-1

5M

ay-1

6

Equity Hybrid Bonds

0100200

Oct

-13

Nov

-13

Dec

-13

Jan-

14Fe

b-14

Mar

-14

Apr

-14

May

-14

Jun-

14Ju

l-14

Aug

-14

Sep

-14

Oct

-14

Nov

-14

Dec

-14

Jan-

15Fe

b-15

Mar

-15

Apr

-15

May

-15

Jun-

15Ju

l-15

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16Fe

b-16

Mar

-16

Apr

-16

May

-16

Jun-

16Ju

l-16

Aug

-16

Sep

-16

TREAS INSTIT MF GOVT INSTIT MF PRIME INSTIT MFGOVT RETAIL MF TAX EM MMFs

S&P 500 ex-Financials: Cash and Equivalents ($Bln)(2) International Money Fund Assets ($,€,£Bln)(3)

1,6001,800

400450

GOVT RETAIL MF TAX EM MMFs

200400600800

1,0001,2001,400

,

50100150200250300350

___________________________.Sources: 1. Investment Company Institute / Haver Analytics.

0200

Mar

-08

Sep

-08

Mar

-09

Sep

-09

Mar

-10

Sep

-10

Mar

-11

Sep

-11

Mar

-12

Sep

-12

Mar

-13

Sep

-13

Mar

-14

Sep

-14

Mar

-15

Sep

-15

Mar

-16

Sep

-16

050

Dec. 31, 2010

Dec. 30, 2011

Dec. 31, 2012

Dec. 31, 2013

Dec. 31, 2014

Dec. 31, 2015

Sept. 31, 2016

CRANE USD MMF INDEX CRANE EUR MMF INDEX CRANE GBP MMF INDEX

2. Barclays Research and FactSet.3. Crane Data’s Money Fund Intelligence.

9

New Connections: Banks, Central Banks, CCPs & Sovereign Bonds, , g

Regulation and unconventional monetary policy has increased connectivity further between banks, central banks and CCPs. In addition, these two forces have linked both entities to sovereign bonds and their presumed cash market liquidity which requires a repo market. What is also interesting is the expectation that banks use the repo market for the provision of liquidity before turning to the last

resort option. Finally, the CCP requires the use of both to manage a member default event.

G l C ll l

Borrow operations from the central bank effectively drains collateral

from the system in order to support cash market activity

A proportion of Bank Buffers contain high quality liquid securities which in a period of stress can either be sold

or used as collateral for repo operations

S

Bank

Central Bank General Collateral

Specific Bond Borrow “Specials”

Cash

Securities

Gov’t Bond Markets

Gov’t Bond Market Making

Desk

Repo Desk

Bank

Liquidity Buffer

€3Tln

Clients(Non Banks)

€3TlnEstimated Sovereign

bond Buffer exposure in Europe(1)

The prerequisite for liquid bond market is a mature repo market; Cost effect funding of inventory

The

Fire

Sal

e D

ebat

e

Cost effect funding of inventory Ease of short covering Support settlement and fails

management Enforceable legal framework Sufficient capital allocation

Repo MarketIn a default a CCP will require both the repo and cash markets to manage liquidity and close out positions

CCPCCP

___________________________.1. Company report and Barclays Research.

10

New Connections: Central Banks & Sovereign Bond Repog p

Central Bank Government Bond Holdings(1)

30%6,000%€Tln

10%

15%

20%

25%

2 000

3,000

4,000

5,000

0%

5%

10%

0

1,000

2,000

2004

Q1

2004

Q2

2004

Q3

2004

Q4

2005

Q1

2005

Q2

2005

Q3

2005

Q4

2006

Q1

2006

Q2

2006

Q3

2006

Q4

2007

Q1

2007

Q2

2007

Q3

2007

Q4

2008

Q1

2008

Q2

2008

Q3

2008

Q4

2009

Q1

2009

Q2

2009

Q3

2009

Q4

2010

Q1

2010

Q2

2010

Q3

2010

Q4

2011

Q1

2011

Q2

2011

Q3

2011

Q4

2012

Q1

2012

Q2

2012

Q3

2012

Q4

2013

Q1

2013

Q2

2013

Q3

2013

Q4

2014

Q1

2014

Q2

2014

Q3

2014

Q4

2015

Q1

2015

Q2

2015

Q3

2015

Q4

Estimated End of Program Purchases byProportion of ECB Purchases

Relative to Estimated Repo

QE in Europe & Repo Market End of Program Estimates (December 2017)

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

Japan United Kingdom United States Euro Zone Japan % United Kingdom % United States % Euro Zone %

Country % Repo Activity Estimated Market Sizeg y

ECB Capital Key(€Bln)p

Market Activity

Germany 20.3% 1,092 435 40%

Italy 10.4% 559 312 56%

F 10 9% 586 347 60%France 10.9% 586 347 60%

Spain 5.9% 317 222 70%

___________________________.1. IMF, Sovereign Investor Base Dataset for Advanced Economies, as of Sept 15, 2016, http://www.imf.org/external/pubs/ft/wp/2012/Data/wp12284.zip2. ICMA Repo Survey, June2016, and ECB.

11

Connections……”the Tie that Binds”

New Regulation has….

…altered the financial landscape by increasing inter-connectedness and creating a system dependent on high quality collateral.

It links the relationship between

….in addition to central banks, defined what constitutes “Good” “Safe” or “High Quality Collateral”

By far the largest asset class which fits this description are sovereign bonds

…..created this, it also produced dependency on capital (balance sheet) in order for banks to act as principles distributing collateral and/or facilitating leverage for non-banks

It links the relationship between physical and synthetic leverage and promotes the use of leverage in non-banks

New connections have extended beyond banks and are now increasing

this description are sovereign bonds

Low volatility and assumed liquidity of the government bonds markets is the foundation

Has the Sovereign - Bank nexus evolved t b th S i Fi i l

The leverage ratio is the measure which is used to monitor, but also the measure used to calculate returns on capital

The measure is asset class and activity between banks and non-banks and in a few cases non-bank to non-bank (shadow banking?)

Increased inter-connectivity has lead to increased counterparty risk, mitigated with collateral

to become the Sovereign – Financial Markets nexus?

blind

Current calibration results in economics which may disincentive banks from increasing capital for Repo to meet future market demand

with collateral

12

Collateral: What Matters - Cost or Quantum?

Defining “Safe”, “Good”, “High Quality” & Availabilityg , , g y yRegulation and Central Banks have defined what are “Safe, High Quality Assets” Regulation and Central Banks have defined what are “Safe, High Quality Assets”

Example Central Bank Eligible Collateral Classifications

ECB Bank of England

Generic HQLA Definition

Cash;Category I Level A

Category II Level B

Category III Level C Securities

Category IV Level C Loan Collateral

1a

Cash; Central bank reserves able to be drawn down in times of stress; Liquid, marketable securities issued or guaranteed by sovereigns, central banks and certain international organisations and which qualify for a 0% risk‐weight under the Basel II standardized approach for credit risk; and Certain non‐0% risk weighted assets may also be included where these match an institution’sjurisdictional currency liquidity needs or operational requirements.

Category V ----j y q y p q

2aNon level 1a assets, these can be included subject to a minimum 15% supervisory haircut to their market value and are capped at 40% (post haircut) of the total buffer.

2bNon level 1a assets, these can be included subject to a minimum 25% supervisory haircut to their market value and are capped at 40% (post

Encumbrance of High-quality Collateral (US$ trillion)(1)Encumbrance of High-quality Collateral (US$ trillion)(1)

Owner Type HoldingsAmount

Encumbered Source of Encumbrance Unencumbered Supply

p y pp (phaircut) of the total buffer.

Governmental institution 8.9 8.9 Inability to engage in securities lending 0.0Commercial Bank 5.3 4.5 Liquid asset buffer or initial margin 0.8Insurance company or pension fund 5.7 0.0 5.7Central banks 4.4 4.2 Mostly lending against other government bonds 0.2Non-resident 11.5 11.3 Foreign exchange reserves 0.2Other 6 0 3 5 Various 2 6

___________________________.1. ECB, Official Journal of the EU, Annex: Table 1, https://www.ecb.europa.eu/ecb/legal/pdf/oj_jol_2016_014_r_0006_en_txt.pdf

Other 6.0 3.5 Various 2.6Total 41.8 32.3 9.5Total post derivatives reform 33.3 8.5

Source: BIS, SIFMA, ECB, IMF. Numbers may not add up due to rounding.

2. BoE, http://www.bankofengland.co.uk/markets/Pages/money/eligiblecollateral.aspx3. BoE SWP#6 609, The Role of Collateral in Supporting Liquidity, Y. Baranova, Z. Liu, and J Noss. Page 5, Table #2, http://www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp609.pdf

13

Availability & Mobility of Collateral: How Does it Work?The availability & mobility of high quality collateral is a function of:

The amount of physical leverage being used in the financial system

The capacity to ‘transform’ low quality collateral into Good collateral

y y

The availability of balance sheet needed to facilitate its movement

The repo market being the primary facilitator of all of the above.

Leverage AgentsLeverage Agents Demand for CollateralDemand for Collateral

Security Lending

Universe ofavailable Bank Liquidity

BankHF

MMKFund

HQLA

HQLAHQLAHQLA

HQLA

CreditCreditCash Cash

C h

Cash

available, not segregatedor encumberedGood Collateral

Leverage Real Money

M i

BufferBank

Bank

CCP Treasury

HQLA

HQLA

HQLA

HQLA

Cash

CashCashEquity

Cash

Cash

Margin Requirements

Security Lending

HQLAEquityCash

14

Collateral: Cost vs. Quantum may be the DriveryMuch has been written about the quantum of collateral which may be needed to support new rules regarding cleared and uncleared

derivatives. The analysis seems to omit how supply and demand translates into actual cost and eventually an economic impact which may have an influence on behaviour.

TreasuryTreasuryUnsecured IM

Cost of collateral measured by the spread between OIS and GC has a direct influence on the cost of carry in a derivatives book

Cost of collateral measured by the spread between OIS and GC has a direct influence on the cost of carry in a derivatives book

CCPCCP

BankSwap Desk

BankSwap Desk

Unsecured Cash

Bond

IM Bond

Balance Sheet transfer

Segregated IMRequirement

FI & CM Desk

FI & CM Desk

IM Bond

0 40

The OIS GC Basis “Cost of Collateral” The OIS GC Basis “Cost of Collateral” Cost of Carry for IM Cost of Carry for IM

0.00

0.20

0.40

40

50

60

As the spread widens, carry increases and may lead to spread widening to compensate the extra carry costs

As the spread widens, carry increases and may lead to spread widening to compensate the extra carry costs

(0.40)

(0.20)

Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16

DE GC O/N IT GC O/N

20

30

1 2 3 4 5 6 7

Unsecured OIS Secured

15

Cost of Collateral: Supply vs. Demand Dynamicspp y yEquity on-loan Value vs. Bund GC-OIS Basis Equity on-loan Value vs. Bund GC-OIS Basis

Equity dividend and script season creates a480500

5

10$BlnBps

Equity dividend and script season creates a higher demand to borrow equities from security lenders (beneficial owners)

Equity borrows requires a pledge collateral. The majority of security lenders stipulate sovereign collateral for the pledge. In Europe this is 360

380400420440460

(15)

(10)

(5)

0

5

specifically core-country issuers, which narrows the eligible collateral pool

Equity borrows are also subject to a haircut/over collateralization of 5-8%

Assume all factors remain equal These transient

300320340

(25)

(20)

Jan-

15

Feb-

15

Mar

-15

Apr

-15

May

-15

Jun-

15

Jul-1

5

Aug

-15

Sep

-15

Oct

-15

Nov

-15

Dec

-15

Jan-

16

Feb-

16

Mar

-16

Apr

-16

May

-16

Jun-

16

Jul-1

6

Aug

-16

Sep

-16

DEGC Basis On Loan Value ($Bln) 7 per. Mov. Avg. (DEGC Basis) Assume all factors remain equal. These transient events or ‘shocks’ present an excellent opportunity to measure how demand impacts the cost of collateral

Based on the evidence, we can observe;

Transient Shock Effect on Collateral Pricing Transient Shock Effect on Collateral Pricing

DEGC Basis On Loan Value ($Bln) 7 per. Mov. Avg. (DEGC Basis)

450 462450

500

The effect is a 7-8bps widening of German collateral (DEGC) basis (GC/OIS)

The market quickly absorbs the additional demand and reverts to normal

C l l ti th iti it lt i 0 8b(9) (9)

(11) (12)(15)(10)

(5)

349 355 369 375

300

350

400

Calculating the sensitivity results in a 0.8bp move in basis per €10bln of additional equity borrow demand

(16)(11)

(19)

(12)

(25)(20)(15)

Normal Dividend Normal Normal Dividend Normal

On Loan Value – Non-Cash ($Bln) DEGC / OIS Basis (Bps)

2015 2016

___________________________.Source: Datalend and Barclays.

16

Collateral Demand: Have we Considered Everything?y g

Inject a large cost to any product or service, without the ability to pass on a majority of the cost and two possibilities occur:

Stage 4Clients Adapt

Stage 5Innovation

1) Triggers a process of product or service evolution2) Start the path of product and service extinction

High costs supports investment in innovation

Industry trading

Stage 3Resource Allocation

Re-pricing

Stage 2Ed ti

Assess client overall franchise value

Concentrate available

Expand counterparty list

Direct trades which compliment a bank’s positioning / help net exposure

Industry trading behaviour evolves; bespoke products become more standardised

The more standardised a

Stage 1Housekeeping

Education

Concentrate available resources to key clients

Adjust Pricing strategy

Finally, increased execution and/or funding cost may make certain strategies obsolete

standardised a product becomes the greater the impact any investment in innovation will have

Standardised OTC products may move

Internally: Inform and and educate Sales and partners

Externally: inform clients, explain the

d

Adjust KPIs Eliminate “lazy products may move

to central clearingreasons and manage expectations

Give them time to adjust

Eliminate lazy trades”

Develop MIS Seek out efficiencies

17

Collateral Demand: Only Time will Tell……y

Product and Service EvolutionProduct and Service Evolution

Results in:

Activity levels decrease and/or innovation takes root

Both outcomes reduces the need for capital to support exposure and improves the return profile

L i l ll t li tiStage 2

Stage 3Resource Allocation

Re-pricing

Less exposure, requires less collateralisation

The reduced need to collateralise exposure leads to reduced demand for collateral

Deflationary pressure on collateral demand

So how accurate are the forecasts for collateral?

Stage 2Education

Stage 4Clients Adapt

Stage 1Housekeeping

Collateral Forecasting Collateral Forecasting

More

dp g

Stage 5Innovation

Col

late

ral D

eman

d

?

Projections Possible Actual

LessTime

18

European Repo Market: Depth, Breadth and Rigidity

European Repo Market: Depth and Breadthp p p Survey data indicates the European repo

market has become smaller since 2010, but roughly the same size over the last 3 years

European Repo market Breadth, How has it changed?European Repo market Breadth, How has it changed?

6

7Tln

69%

70%

6

7

%Tln

Reduction from BBB rated institutions seems intuitive as banks may be under pressure to reduce leverage or have higher funding costs thus makes them less competitive

1

2

3

4

5

6

64%

65%66%

67%68%

69%

1

2

3

4

5

6

GSIB designated banks reduced activity but are still a major player

The majority of banks that contribute to repo market activity in Europe are domestic but this number is on a declining trend

0

1

Jun-

10

Dec

-10

Jun-

11

Dec

-11

Jun-

12

Dec

-12

Jun-

13

Dec

-13

Jun-

14

Dec

-14

Jun-

15

Dec

-15

Jun-

16

Total A/AA Total BBB

62%63%

0

1

Jun-

10

Dec

-10

Jun-

11

Dec

-11

Jun-

12

Dec

-12

Jun-

13

Dec

-13

Jun-

14

Dec

-14

Jun-

15

Dec

-15

Jun-

16

GSIB NonGSIB EU % Total

declining trend

Breadth? Repo market is less concentrated with the top-3 declining with top-5 and especially top-10 taking up a bigger proportion of the market.

European Repo Market, What about Depth?European Repo Market, What about Depth?

1601807

BlnTln

100%%

Depth? In the repo market, there is less flexibility to apply some simple assumption to assess balance sheet capacity, given sudden client flows/shocks or increased demand for collateral intermediation40

6080100120140160

2

3

4

5

6

20%

40%

60%

80%

collateral intermediation

New entrance provides breadth but how much depth in a stressed situation and what about their stability

How to measure?

020

0

1

Jun-

10

Dec

-10

Jun-

11

Dec

-11

Jun-

12

Dec

-12

Jun-

13

Dec

-13

Jun-

14

Dec

-14

Jun-

15

Dec

-15

Jun-

16

Depth (RHS) Size

0%

Jun-

10

Dec

-10

Jun-

11

Dec

-11

Jun-

12

Dec

-12

Jun-

13

Dec

-13

Jun-

14

Dec

-14

Jun-

15

Dec

-15

Jun-

16

Top-3 Top-5 Top-10 The Rest

___________________________Data Source: ICMA Repo Survey, June 2016.

19

Balance Sheet Rigidity: Can we Identity any Evidence?g y y y

Brexit – Balance Sheet IndigestionBrexit – Balance Sheet Indigestion

1250 60Px (Normalized)Rate (%)

115

120

125

0.45

0.50

0.55

0.60

100

105

110

0.30

0.35

0.40

90

95

0.20

0.25

Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16

SONIA GBPGC 10 yr gilt 1Jun=100 (RHS) 30 yr gilt 1Jun=100 (RHS)

Brexit was the catalyst for a sharp upward asset price revaluation, est. at 8-15% The move would have resulted in the requirement of more capital to support the

same positions, a simple estimation could be £36blnGross B/S Position

Estimated Asset Value Move (%)

DeltaImpact

Simple Assumptions for leveraged UKT Balance sheet FootprintSimple Assumptions for leveraged UKT Balance sheet Footprint

SONIA GBPGC 10 yr gilt 1Jun=100 (RHS) 30 yr gilt 1Jun=100 (RHS)

Data suggests a £10bln increases results in a ~1.5bp increase in Gilt GC ratesUK LDI (Leveraged Pension Fund) £200Bln 15% (30yr) £30Bln

Dealer (GEMS) £30Bln 8% (10yr) £2.4Bln

Leveraged Asset Management £50Bln 8% (10yr) £4.0Bln

Total £280Bln £36.4Bln

___________________________Source: Bloomberg and Barclays.

20

Cost of Balance Sheet: Evidence of Re-pricing? p g

Lending from UK MFIs to Various Client Bases(2)Lending from UK MFIs to Various Client Bases(2)European and US Bank Leverage(1)European and US Bank Leverage(1)

140GBP Bln

18x50x

60

80

100

120

140

13x

14x

15x

16x

17x

18x

30x

35x

40x

45x

50x

0

20

40

Jan-

11

Jul-1

1

Jan-

12

Jul-1

2

Jan-

13

Jul-1

3

Jan-

14

Jul-1

4

Jan-

15

Jul-1

5

Jan-

16

Jul-1

6

10x

11x

12x

15x

20x

25x

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

e20

17e

Spread Curve (Gilt GC to Sonia)(3)Spread Curve (Gilt GC to Sonia)(3) UK Gilt 30 year Swap Spread(3)UK Gilt 30 year Swap Spread(3)

Insurance Co Pensions Funds Fund Management

0.25

Bps

Europe (All), LHS US (Commercial Banks), RHS

8090

Bps

0.05

0.10

0.15

0.20

203040506070

___________________________1. Barclays Research.

0.00ON 2W 1M 2M 3M 6M 12M

2016, 6 Oct 2015, 6 Oct 2014, 6 Oct

010

Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16

30yr Gilt Swap Spread

2. Data from Bank of England Statistical Interactive Database using codes: RPMB3V6, RPMB3W4, RPMTBVU 3. Barclays Data.

21

The Regulatory Pendulum: Direction of Travel?g yFollowing the events of 2008, there was little doubt that the regulatory pendulum would swing in the direction of a more

uncompromising application of regulation in order to promote macro prudential stability. New regulation was written against the backdrop of a caustic political environment, with the then available evidence and with no credible ability to fully assess its impact.

Eight years later, we have new facts, we’re starting to observe unintended consequences and regulators are asking questions.g y , , g q g g qIs there enough evidence to support delaying the regulatory pipeline and/or recalibrate existing rules?

2008

Today

? Finalised European NSFR rules

Limitation on collateral re-use

Minimum HC & countercyclical requirements

The idea of “counterparty” agnostic lending

MiFiD 2 – Best Execution applies?

22

Farewell 2016…. Welcome 2017

2016: GC Starts Turning Special?g p

1,400(0 100)

0.000 1,400

Rising Impact from Specials(1)Rising Impact from Specials(1) PSPP Cumulative Holdings (€mm)(2)PSPP Cumulative Holdings (€mm)(2)

400

600

800

1,000

1,200

(0 800)(0.700)(0.600)(0.500)(0.400)(0.300)(0.200)(0.100)

400

600

800

1,000

1,200

0

200

(1.000)(0.900)(0.800)

Dec

-15

Dec

-15

Jan-

16Fe

b-16

Feb-

16M

ar-1

6A

pr-1

6A

pr-1

6M

ay-1

6Ju

n-16

Jun-

16Ju

l-16

Aug

-16

Aug

-16

Sep

-16

Oct

-16

Nov

-16

Nov

-16

Dec

-16

Jan-

17

Excess Liq (rhs) DEGC REFR DE

0

200

Dec

-15

Jan-

16

Feb-

16

Mar

-16

Apr

-16

May

-16

Jun-

16

Jul-1

6

Aug

-16

Sep

-16

Oct

-16

Nov

-16

Dec

-16

PSPP Cumulative

Number of Bonds Trading >10bps Through GC(3)Number of Bonds Trading >10bps Through GC(3)

250300350

050

100150200250

an eb ar

Apr ay un Ju

l

ug ep Oct ov ec an eb ar

Apr ay un Ju

l

ug ep Oct ov ec an eb ar

Apr ay un Ju

l

ug ep Oct ov ecJa Fe M A Ma Ju J Au

Se O No

De Ja Fe M A Ma Ju J Au

Se O No

De Ja Fe M A Ma Ju J Au

Se O No

De

2014 2015 2016

Core Peripheral GB

___________________________1. ECB , Bloomberg, and Barclays Data; 2. ECB; 3. Barclays Data

23

2016: Fails & Market Function Shrinkage of the repo balance sheet, dealers holding less inventory and central bank purchases (QE) has raised the questions if

settlement fails are becoming more common. An increase in settlement fails not only makes balance sheet and liquidity management more difficult but begins to erode confidence in market liquidity.

In Europe there are no public sources of market fails data. Th b l h t ill t t ISCD t b ti it th k t’ l t f t t t t f il

300

The below charts illustrates ISCD auto-borrow activity, the market’s last safety net to prevent a fail.

ICSD Auto-Borrow Activity Month-on-Month Change Index, Jan 2012 = 100 (1)ICSD Auto-Borrow Activity Month-on-Month Change Index, Jan 2012 = 100 (1)

150

200

250

0

50

100

n-12

r-12 l-1

2

t-12

n-13

r-13 l-1

3

t-13

n-14

r-14 l-1

4

t-14

n-15

r-15 l-1

5

t-15

n-16

r-16 l-1

6

t-16

Jan

Apr

Ju Oc t

Jan

Apr

Ju Oc t

Jan

Apr

Ju Oc t

Jan

Apr

Ju Oc t

Jan

Apr

Ju Oc t

E/C (Sov. Only) C/S

___________________________Source: Euroclear & Clearstream

24

2016: What Happened at Year End?

(5%)0%

pp

Not one but a number of factors may have contributed to the price

Where’s the smoking gun(s)?Where’s the smoking gun(s)? Was FX basis a factor?(1)Was FX basis a factor?(1)

S/N T/N O/N

(35%)(30%)(25%)(20%)(15%)(10%)

(5%)Not one but a number of factors may have contributed to the price action we experienced:

1. Balance sheet constraints & Management

2. Cash hunting for a home

3. Lack of ‘safe assets’

(45%)(40%)( )

22:0

000

:24

02:4

805

:12

07:3

610

:00

12:2

414

:48

17:1

219

:36

22:0

000

:24

02:4

805

:12

07:3

610

:00

12:2

414

:48

17:1

219

:36

22:0

000

:24

02:4

805

:12

07:3

610

:00

12:2

414

:48

RRP EUR Eqv Core € GC

4. X-CCY basis

5. Cash market positioning

6. Levy/Tax policies influencing behaviour 28th Dec 29th Dec 30th Dec27th

RRP EUR Eqv Core € GC

Money Fund £ Weighted Average Rate(2)Money Fund £ Weighted Average Rate(2) Money Fund € Weighted Average Rate(2)Money Fund € Weighted Average Rate(2)

0.70%%

(0 5%)

0.0%%

(0 30%)

(0.10%)

0.10%

0.30%

0.50%

(3.0%)

(2.5%)

(2.0%)

(1.5%)

(1.0%)

(0.5%)

(0.50%)

(0.30%)

Dec

-15

Jan-

16

Feb-

16

Mar

-16

Apr

-16

May

-16

Jun-

16

Jul-1

6

Aug

-16

Sep

-16

Oct

-16

Nov

-16

Dec

-16

(4.0%)

(3.5%)

Dec

-15

Jan-

16

Feb-

16

Mar

-16

Apr

-16

May

-16

Jun-

16

Jul-1

6

Aug

-16

Sep

-16

Oct

-16

Nov

-16

Dec

-16

___________________________1. Barclays and Bloomberg Data; 2.. Craine Data

25

2017: What Could we Expect? p

Balance Sheet & Behaviour Continues to Evolve

Demand for Collateral remains constant with up-side risk in light of uncleared derivative margin requirements

Supply of short end ‘safe assets’ & Collateral Remains Challenged

Increased Specials Activity & a Possible Increase in Fails

Cleared swaps VM demand will influence 2H17 demand for balance sheet

Make or break time for new business models built on sponsored clearing & bank disintermediation

NCB become larger participants in the repo market as a result of lending QE holdings

Could we see RRP in Europe or the UK?

Regulation, the Final Stretch, Pause and/or Recalibration?

European Money market Reform & US Earning Repatriation

g

26

2017: Balance Sheet & Behaviour We are fast approaching 2019 and banks are busy executing their publically stated capital and leverage plans. The leverage solutions

take the form of either deleverage and /or increase capital base. Also worth noting currently only 3 jurisdictions in this sample have binding leverage rules (US, UK & Switzerland).

Citi BoA

Citi

6 5%

7.5%2Q16Proforma/2018

JPM BoA

GS MS

JPM

BoA

GS MS 5.5%

6.5%

e ra

tio

HSBC

GS MS

CS Barc

HSBC

4.5%

CE

T1 le

vera

ge

4%

5%

DB

CS UBSBNP

SG

Barc

DBUBSBNP

SG

Barc

3.5%

3% Basel 3 Minimum

4%

DB

2.5%9% 10% 11% 12% 13% 14% 15% 16% 17%

CET1 ratio___________________________Source: Barclays ResearchNote: US Banks based on GAAP.

27

2017: Balance Sheet & Behaviour

In the past, intra-quarter end leverage increases were standard market practice. Now that leverage is a key focus, reporting is done on an average basis rather than at specific points in time, thus avoiding the opportunity for ‘window dressing’. This reduces volatility, but

also reduces the repo balance sheet between the traditional reporting periods.

Traditional repo balance sheet management

160

180

200

behaviour

80

100

120

140

J F b Q1 A il M Q2 J l A Q3 O t N Q4Jan Feb Q1 April May Q2 July Aug Q3 Oct Nov Q4

Quarter Target Monthy Target Daily Target

This type of behaviour is not only limited to Repo but any activity which is easy to ‘dial up and down’ and impacts leverage. Examples include cash trading and a bank’s treasury desk taking advantage of arbitrage opportunities.

28

2017: Balance Sheet & Behaviour Sterling Off-Shore Money Fund Collateral Borrows (GBP)

French and Canadian Banks(1)Sterling Off-Shore Money Fund Collateral Borrows (GBP)

French and Canadian Banks(1)USD On-shore Money Fund Holding (Indexed 2012 =100)USD On-shore Money Fund Holding (Indexed 2012 =100)

4.5Bln

250

1 01.52.02.53.03.54.0

50

100

150

200

0.00.51.0

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Dec

-15

Feb-

16

Apr

-16

Jun-

16

Aug

-16

French Banks Canadian Banks

0

Jan-

14

Mar

-14

May

-14

Jul-1

4

Sep

-14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-1

5

Sep

-15

Nov

-15

Jan-

16

Mar

-16

May

-16

Jul-1

6

France UK Canada Switzerland US GSIB

Note: US GSIBs include: BoA Citi GS JPM MS and Wells Source: Crane’s Data Barclays Research

Sterling Off-Shore Money Fund Collateral Borrows (GBP)US Banks

Sterling Off-Shore Money Fund Collateral Borrows (GBP)US Banks

Sterling Off-Shore Money Fund Collateral Borrows (GBP)UK Banks

Sterling Off-Shore Money Fund Collateral Borrows (GBP)UK Banks

French Banks Canadian Banks

4.04.5

Bln

5 0

6.0

Bln

Note: US GSIBs include: BoA, Citi, GS, JPM, MS, and Wells. Source: Crane s Data, Barclays Research.

0.51.01.52.02.53.03.5

1.0

2.0

3.0

4.0

5.0

___________________________Source:

0.0

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Dec

-15

Feb-

16

Apr

-16

Jun-

16

Aug

-16

US Banks

0.0

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Aug

-14

Oct

-14

Dec

-14

Feb-

15

Apr

-15

Jun-

15

Aug

-15

Oct

-15

Dec

-15

Feb-

16

Apr

-16

Jun-

16

Aug

-16

UK Banks

1. Barclays US Money Market Update, 30Sept16. http://my.barcapint.com/PRC/servlets/dv.search?contentPubID=FC2263007&bcllink=decode2. Crane Money Market Data.

29

2017: Collateral QuestionEGB Issuance, QE and Demand for Margin , g

In 2017, depending on the demand for collateral, market positioning and the available balance sheet/use of leverage, GC may become more expensive with specials activity remaining elevated. The two main observable reasons are; the ECB will purchase ~€780bln of securities if the QE programs ends when announced (Dec-17) and Euro governments will issue less securities than they did in 2016.

€ blnGross

Issuance (A) (∆ vs. 2016e) Bond

Redemptions (B) (∆ vs. 2016e)Net Issuance

(A-B) (∆ vs. 2016e) Net Issuance

Post QE Coupons (C)Net Cash Flow

(A-B-C) (∆ vs. 2016e) Net Cash Flow

Post QE

Germany 160 0.5 142 -26.5 18 27 -117.4 21.1 -3.1 8.7 -138.5

France 211 -3.5 121.8 -5.2 89.2 1.7 -21.1 38.7 50.5 -5.6 -59.8

Italy 250 18.6 215.6 31.6 34.4 -13 -67.4 44.5 -10 22.8 -111.9

Spain 123 2.8 87.1 1.5 35.9 1.3 -36.6 27.2 8.7 -2 -63.8

Other 146.4 12.7 133.7 29.4 12.7 -16.8 -97.3 38.7 -26 -17.9 -136.1

Total Euro 890 31 700 31 190 0.3 -340 170 20 6 -510

___________________________S B l R h Gl b l R t W kl 12 J 2017 “E 2017 l d h fl ”Source: Barclays Research , Global Rates Weekly, 12 January 2017, “Euro area 2017 supply and cash flows”Note: France forecast is gross issuance; net of buybacks the French target is officially €185bln.

30

THANK YOU

31

General Conflict Disclosure & DisclaimerBARCLAYS

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32

General Conflict Disclosure & Disclaimer (Continued)OPINIONS SUBJECT TO CHANGEAll opinions and estimates are given as of the date hereof and are subject to change. The value of any investment may also fluctuate as a result of market changes. Barclays is not obliged to inform the recipients of this communication of any change to such opinions or estimates.

NOT FOR RETAILThis document is being directed at persons who are professionals and is not intended for retail customer use.

( )

g p p

IMPORTANT DISCLOSURESFor important regional disclosures you must read, visit the link relevant to your region. Please contact your Barclays representative if you are unable to access. EMEA https://www.home.barclays/disclosures/important-emea-disclosures.html. APAChttps://www.home.barclays/disclosures/important-apac-disclosures.html. p y p pU.S.https://www.home.barclays/disclosures/important-us-disclosures.html.

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33