1. Cleared Term DBV
23 July 2013

2. Key dates February 2014: March 17 2014: April 2014:
Market testing on an end-to-end LCH.Clearnet/CREST test platform
March :
Euroclear UK & Ireland launch underpinning settlement changes to the CREST system.
April 2014:
LCH.Clearnet launch their new Term £GC service and start the transition from the current Sterling GC service.

3. AGENDA Term DBV: a perspective from the Bank’s front office
Andrew Hauser: Head of Sterling Markets Division
The case for change
Toby Davies: Head of Market Services Division
Key features of the new Cleared Term DBV service
CREST system enhancements: David Nicholas, Euroclear UK & Ireland.
New Term £GC product: Nigel Bradley, LCH.Clearnet.
Sub-group update, and member actions required
Ian Fox: Chair, MMLG sub-group for Cleared Term DBV.
Q&A (Panel session)
Closing remarks
Ian Mair: Chair, London Money Market Association

4. Cleared Term DBV
23 July 2013

5. Term DBV: a perspective from the Bank’s front office
Andrew Hauser
Head, Sterling Markets Division
Chair of Money Market Liaison Group
Chair of Securities Lending and Repo Committee

6. From small acorns...

7. ...secured flows now dwarf unsecured
Average daily turnover in sterling money market (Nov 2012)

8. Gradual shift to secured: a global trend
Secured transactions as share of total turnover

9. Improving market resilience
Repo reduces (though not eliminates!) counterparty risk
But highly collateralised world increases macroprudential risks – some of which crystallised during the financial crisis
Global response overseen by Financial Stability Board:
Main focus on ‘procyclicality’
But mitigating operational risk also important
UK challenges not on same scale as eg US triparty - but mismatch between daily DBV settlement unwind and term of underlying deals does pose operational and liquidity risks

10. Term DBV volumes: the only way is up!

11. The Bank’s front office interests
Broad interest in stability of the market: key transmission channel for monetary policy
DBV central to Bank’s own operations:
Peak daily value during crisis = £85bn
From July 2011, Bank counterparties have had option of using Term DBV in OMOs and OSFs...
...and we made it clear that we were ‘minded to discontinue use of Rolling Overnight DBV’
MMLG oversight

12. “The system may be safer, but what’s in it for me?”
Safer system benefits everyone, but also...
Settlement costs and exposures (Toby Davies will cover)
Margin costs (LCH.Clearnet will cover)

13. “The system may be safer, but what’s in it for me?”
Safer system benefits everyone, but also...
Settlement costs and exposures (Toby Davies will cover)
Margin costs (LCH.Clearnet will cover)
Front office engagement crucial to success of the exercise
Good practice guidelines (Toby/Ian will cover)

14. Cleared Term DBV
23 July 2013

15. The case for change Toby Davies Head of Market Services Division
23 July 2013

16. Current DBV mechanism Current overnight DBV model is tried-and-tested
low cost easy way of delivering market-defined baskets of GC
no substitutions or mark-to-market needed because collateral is returned every morning
reliable
But it masks hidden issues
an inefficient and risky churn of daily return and reissue
dependency on provision of central bank liquidity through auto collateralised repo to fund intraday positions

18. Risks
In the event of a counterparty or system-wide outage intraday between morning unwind and afternoon re-input:
DBV counterparties would be left holding the ‘wrong’ asset
counterparties would be required to manage liquidity dislocation
DBV counterparties and their CREST settlement banks would be left with credit exposures
the Bank would be left with intra-day liquidity extension to settlement banks that might need to be converted into overnight facilities
The values are substantial

19. 11 November 2011
Severe SWIFT outage on 11 November 2011 meant many of the day’s DBVs (including LCH’s) could not be submitted until very late in the day
DBV value input after the outage was resolved was £159bn
Outstanding IDL (a large proportion of which is normally repaid automatically in afternoon DBVs) was at £82bn at the point of failure

20. The challenge The Bank has been exercised by the risks for many years
Objective is to align the settlement arrangements with the underlying economic terms of the repo
not to change the fundamental form of the trade
The challenge is to reduce risks while retaining the benefits of the DBV basket collateral mechanism.
The introduction of Term DBV within CREST in 2011 provided an underlying mechanism
but could not gain sufficient traction without being cleared through LCH.C which accounts for ~40% of DBV value settled.

21. Key characteristics
Principal exchanged on term basis
Daily mark-to-market
Automatic and manual substitution

22. Benefits From reduction in daily cash and collateral settlement flow
in aggregate, less credit needed for settlement
reduced position management ahead of DBV settlement window
reduced reliance on central bank liquidity provision
Tail risk
reduced risk from operational interruption
only overnight and new business exposed to intraday interruption
reduced potential dislocation of liquidity

23. Good market practice is essential
collateral giver
to maintain pool of eligible collateral to feed mark-to-market and substitutions
collateral taker
to ensure substitutions do not fail by keeping received collateral available for substitution and return
CREST is able to manage substitutions because it recognises a closed loop of collateral given/received in DBV. This breaks down if you deliver away received stock other than as DBV.
Two approaches:
Hold stock in segregated account
Careful position management

24. Summary Focus today is LCH introduction of a cleared Term GC product.
The issue is to align the settlement process with the economic terms of the repo
without fundamentally changing the latter
The objective is to reduce potentially significant risk in the event of a counterparty or system-wide outage that prevents DBV settlement
The change will need to be carefully coordinated.
Over to David Nicholas to describe the EUI changes, before Nigel Bradley sets out the LCH product changes.

25. Cleared Term DBV
23 July 2013

26. Clearing Term DBV Bank of England Seminar 23 July 2013

27. Functional Overview Input and selection Mark to Market
Uses existing DBV algorithm (basket based and size first)
Return date (1 day – 2 years)
Settling between 3:00pm and 4:10pm
Mark to Market
Overnight: identifies DBVs that are incorrectly collateralised (based on closing price)
Intraday: Generates transaction to rebalance collateral levels to cover cash value of transaction
Generated (in full or partial) if stock is available
Links across multiple transaction legs (even where position is flat)

28. Functional Overview Substitutions (Eligibility & Giver Recall)
Automatic recall based on Corporate Action or settlement need
Delivery versus delivery
Runs throughout the day to support settlement fails
Recall/substitution possible over a wide chain/array of transactions
Adjustments
Ability to adjust the value of collateral sought, consideration or length of term during the term of the DBV
Interest Calculation
Interest accrued daily for length of term (TDI)

29. Recall Substitution Simple Substitution (Bilateral model)
Day 1: delivers £100m DBV (UBG) 7 day term
Day 2: Party A delivers £25m gilt 1 to Party C
DBV £100m UBG
Party A
Party B
7 day term
£50m Gilt 1
£50m Gilt 2
£100m Gilt 3
Party A
Party B
Sub (TDG) £25m Gilt 3
£75m Gilt 3
Sub (TDG) £25m Gilt 1
£25m Gilt 1
£50m Gilt 2
£25m Gilt 3
DEL £25m
Gilt 1
Party C

30. Recall Substitution Complex Substitution Mbr F Mbr H Mbr X Mbr A Mbr B
CCP is less vulnerable to subs fails given the large number of counterparty holdings
TDG £5m Gilt 2
Mbr F
Mbr H
DEL £30m
Mbr X
Mbr A
TDG £5m Gilt 1
Gilt 1
TDG £10m Gilt 2
TDG £30m Gilt 2
TDG £10m Gilt 1
Mbr B
TDG £30m Gilt 1
Mbr G
LCH
TDG £20m Gilt 2
Mbr C
TDG £20m Gilt 1
Mbr H
Mbr D
Mbr I
Mbr E

31. Cleared Term DBV Enhancements
Direct input of Term DBVs and Term DBV Adjustments from LCH.C
Support settlement of Giver Recall Substitutions, Term DBV Maturity Returns and Own Account Transfers alongside DBV settlement in order to satisfy settlement efficiency/minimise fails
Support early closing of a open term DBV via LCH
Substitutions triggered by Term DBV Amendment (during DBV settlement)
Removal of diary time slicing (full availability of substitutions)
Support of negative interest rates

32. Market Practice
Successful operation of substitution functionality – dependant on collateral being maintained within collateral arrangements (no onward Delivery of Collateral other than by Term DBV)
Substitution not possible where collateral moved outside collateral arrangements
No enforcement tools
No Settlement Discipline regime
Requires adherence to good market practice
Options to avoid unintentional delivery of collateral outside of collateral arrangements:
Account Segregation - Main Trading and Collateral Accounts
Single Account – inventory management challenge

33. Account Segregation
DBVs ‘Collateral Account’ separate from Main Trading Account
Advantages:
no possibility of unintentional delivery of collateral outside of collateral arrangements
Clear view of Available Balance (securities available to trade/deliver)
Disadvantages
Account rebalancing necessary (top up/draw downs)
Own Account Transfers in DBV settlement window
Movements in individual lines of securities

34. Single Account
Single account for all activity (DBVs and Main Trading Account)
Advantages:
Maximum flexibility
Disadvantages
Requires accurate management of positions
Clear view of what is held as collateral
What is available for delivery
To support a single account:
Addition of ‘non Collateral Balance’ to CREST GUI and FT DEX messages (derived) – visibility of unencumbered balance
Available Balance – Collateral Balances

35. DBV Reporting Tools To support the market: Report per participant
Highlighting any inadvertent breaches of good practice
Nil Return Report – confirming non-breaches
Monthly summary reports
No participant details
Persistent breaches – highlighted to participants individually

36. Testing Availability
Test Environment available for testing Term DBV functionality
Block Booking – Nov/Dec 2013
No charge for testing during this period

38. Cleared Term DBV
23 July 2013

39. Term £GC Product Overview
Bank of England
23 July 2013

40. Term £GC Overview Term £GC Sterling GC Trading TDBV Settlement
GB00B1347K44
GB00BC7H8L40
TDBV Settlement
DBV Settlement
Term £GC
Product Definition
Sterling GC
Product Definition
Features of cleared product
Settlement mechanism
Term £GC Key Benefits
Reduced operational risk and settlement credit needs due to the elimination of the requirement for daily return of cash and collateral compared to the current Sterling GC product.
Introduction of margin offsets between trades relating to specific bonds e.g. the existing cleared Gilts market, and allocations resulting from Term £GC trades.

41. Term £GC Overview
Sterling denominated repo trades based on the CREST Unstripped British Government (“UBG”) Delivery by Value (“DBV”) class.
Term £GC will be made available for trading via electronic trading platforms and anonymous trading will be available.
Bilateral and voice brokered trades will also be supported.
Overnight trades and term trades (up to 374 day term) accepted.
Settlement, using Euroclear UK & Ireland’s (“EUI”) Term DBV (“TDBV”) settlement platform, is
instructed by RepoClear and automatically matched via the Direct Input facility.
Collateral allocated as part of a Term £GC trade can be substituted in the same manner as any
other collateral utilised within the TDBV environment.
Participants’ positions will be maintained in CREST utilising standard Mark to Market functionality
augmented with LCH.Clearnet Risk management processes.

42. Term £GC – Trading, Clearing and Settlement

43. Trade Registration
Trade registration supported from to (all times are London time)
Cut off for registration of trades for same day settlement: 14.30
Fixed term trades
Fixed repo rate (positive, negative or zero)
Cash fill basis (defined in GBP)
Based on EUI’s definition of Unstripped British Gilt (“UBG”) class
Consistent with Sterling GC
LCH.Clearnet retains ability to exclude specific ISINs
Overnight to 374 day terms will be supported
Forward start periods of up to 374 days
ISIN listed n Bloomberg.

44. Risk Management Initial Margin
Term £GC trades will be margined both intra-day and at end of day.
For trades received on a same day settlement basis, IM will initially be calculated based on a synthetic allocation of bonds.
Once the settlement allocations are known, positions will be margined based on the actual allocations as part of all subsequent margining processes.
Initial margin offsets will be supported between Term £GC trades and trades executed against specific collateral cleared via the existing Gilts market.
Variation Margin
Variation Margin will be called to reflect the change in the net present value of the repo interest only.
Delivery Margin
Delivery Margin will not be applicable to Term £GC (as per Sterling GC).

45. Risk Management Intra-day Risk Management
Term £GC will utilise the standard CREST TDBV functionality which adjusts collateral levels on a daily basis to ensure that the value of collateral appropriately covers the cash value of the transaction.
This will be augmented with an additional level of market risk management by LCH.Clearnet

46. Settlement Netting
The settlement netting process for Term £GC will be run as two independent steps: “Term Netting” and “End Date Netting”
Term Date Netting
The Term Netting process will seek to offset trades for which settlement will
be instructed “Today” (Day1 in the graphic) where trades have the same start and end date.
As per the graphic, in the Day 1 Term Netting process, trades 1 and 2 are netted to produce a settlement instruction for +£30mn
End Date Netting
This process examines the positions that have been instructed for settlement in CREST previously and
determines whether those existing positions can be increased or decreased in size, or potentially terminated in order to minimize the level of open positions within the TDBV settlement platform for the participant.
On Day 1 there are no positions that have been previously instructed for settlement, so no End Date netting takes place.

47. Settlement Netting
TDBV Settlement Position in CREST following Day 1 netting
As a result of the netting and settlement instruction which took place on Day 1, there is now a settlement position in place in CREST for +£30mn which has an end date of day 7.
On day 2, there is only a single trade for the counterparty so no Term Date netting can take place.
However the trade for -£20mn with an end leg settlement date of the day 7 must be considered for End Date netting.
Thus, the new trade and the existing position are End Date netted and the existing TDBV position in CREST is reduced from £30mn to £10mn.
TDBV Settlement Position in CREST following Day 2 netting
Mention that there are multiple possible outcomes of this end date netting process.
Existing value can
Increase
decrease or be cancelled.

48. Settlement Netting Repo Interest
A separate netting process is utilised with respect to repo interest payments such that, on a daily basis, a single net repo interest payment in respect of all closing trades is instructed to CREST for settlement as a cash-only payment .
This mirrors the process that is used in the current Sterling GC product.
Settlement Instruction
LCH.Clearnet submits all settlement instructions using the CREST Direct Input facility so that participants do not need to instruct or match in CREST themselves as a “business as usual” activity.
This facility is used for all settlement instruction including the amendment of the size/early termination of settlement positions.

49. Substitution of Collateral
The use of collateral substitution within the Term £GC product is twofold:
In line with the bilateral market, substitution will be used by collateral givers where a specific bond is required in relation to a participant’s Delivery vs. Payment or Free of Payment transaction.
In relation to the Term £GC product specifically, substitution transactions will be automatically generated to support the return of the correct collateral to its original giver as part of the end leg settlement process.
The volume of substitution transactions which could be generated as a result of collateral return process may be significant:
On any given day there are likely to be multiple givers of collateral to LCH.Clearnet and multiple recipients of collateral from LCH.Clearnet.
Collateral delivered to LCH.Clearnet on an overnight basis may be allocated to a collateral taker on a term basis.  
It is essential that collateral which is allocated to participants as a result of the settlement of Term £GC trades is available for substitution using standard CREST Term DBV functionality.
Any costs incurred by LCH.Clearnet as a result of substitution failure in these circumstances will be charged to the member who fails to support the requested substitution.

50. Tariff Structure Registration Fees
Registration fees for Term £GC trades will be charged on an ad-valorem basis as per the below table using a 360 day count convention:
The first 1-7
The next 8-90
The
In addition, a processing fee of £0.70 is levied per registered trade.
This fee structure is the same as that which is currently in place for Sterling GC.
Settlement Fees
Settlement related costs incurred by LCH.Clearnet in settling participants’ Term £GC positions in the EUI Term DBV settlement system will be recovered from participants.

51. Programme Timeline What is available now?
Clients wishing to clear Term Sterling GC will need to interact directly with the CREST TDBV system. The CREST TDBV test environments are already available for Clients to utilise in their internal development processes.   
The Term £GC product description is published which can be used as a basis for Participants internal development processes.
Additional technical specifications will be available from both LCH.Clearnet and EUI in September 2013.
EUI are developing additional functionality for LCH.Clearnet to support Term £GC, which is scheduled to go live on 17 March 2014.
LCH.Clearnet Member testing scheduled to commence February/March 2014.
Term £GC will go live in April 2014, following a period of around a month of the CREST changes running in the production environment.
What is available now?
Implementation timeline

52. Transition of Liquidity to Term £GC
Following the go-live of Term £GC, the current Sterling GC product will be continue to be available for a period of time and the two products will be supported in parallel.
Whilst pragmatic as a short term solution, this approach is likely to lead to an undesirable split of liquidity across the two products.
Will seek to create an environment where a high proportion of existing
Sterling GC users are able to trade the new Term £GC product from
launch such that there is a natural transfer of liquidity into Term £GC.
At a point in time three months after the launch of Term £GC it is
proposed to withdraw the Sterling GC product such that new trades
can no longer be registered.
Based on the current maturity profile of Sterling GC, 99% of all open trades would mature within the 3 month period leaving only a small proportion of trades to be transferred across to the new product.

53. Contacts and Additional Information
For further information on the Term £GC product, please contact: Manisha Mistry Tel: Or Nick Maggs Tel:

54. Cleared Term DBV
23 July 2013

55. Cleared Term DBV Sub-group Update Member Actions Required Ian Fox 23 July 2013

56. PROGRESS SO FAR
Initiative launched by Chris Salmon 24th Jan 2013 – speech to LMMA
Sub-group of MMLG created to co-ordinate the work required to introduce and adopt the new product
Sub-group includes representatives from EUI, CREST, LMMA, DMO, ISLA, Bank of England, major repo trading banks
Product design proposed by LCH / EUI and agreed
Implementation timelines drawn up
Changed cost impacts assessed
Market discipline regime agreed

57. MARKET ADOPTION IS KEY
Objective has always been to get widespread support to ensure good market liquidity
Aim of the sub-group is therefore ensuring that the product is fit for purpose for market participants and they are ready to use it – this is key to finalising the implementation process
Sub-group has been widened to ensure greater representation
Communication of CTDBV plans through:
MMLG
SLRC
LMMA
ISLA
BBA
Major market traders

58. MEMBER ACTIONS REQUIRED
Expectation that new CTDBV product will be introduced in mid 2014 – so preparations should begin now if not already started:
Full understanding of product design, settlement routine changes
Asses impact on existing business / trading habits
Scope changes to existing processes / habits
Model cost impacts
Engage with LCH / EUI as necessary (detailed documentation available on websites)
Ensure suitable collateral position monitoring and management
Timely focus on IT changes (if required)
Commit resources to market testing of both BAU and migration process
Existing LCH DBV product will be discontinued after a short period of parallel running (EUI o/n DBV product will continue)

59. LLOYDS – PREPARATIONS UNDERWAY
Front Office and Back Office have been engaged on the project since January.
Full understanding of product and changed trading and settlement requirements.
Little technical IT changes required.
Main action is to segregate CTDBV from trading inventory – separate CREST accounts and enhanced Front Office MI.
Modelling of settlement / trading cost impacts has been performed.
Review of policy and procedure documents – including second line oversight review.
Will be fully engaged in testing. Counterparty engagement to follow.

60. NEXT STEPS
Sub-group will continue to steer through CTDBV – particular focus on testing outcomes
Continued communication as wide as possible
Comments / issues welcomed
Bank of England will write to market participants in September to get confirmation of market readiness
New product could be used to term out current large o/n DBV positions used to collateralise stock borrowing transactions

61. GOOD PRACTICE FRAMEWORK
Fails – not acceptable, but no financial penalties beyond recharge of costs incurred
Exploring feasibility of daily fails reporting
Exploring feasibility of system flags to avoid stock being removed from the CTDBV cycle
Existing EUI / LCH rules to apply, updated as required
Bank of England to update 2011 “TDBV Good Market Practice” document
Eventual update to Gilt Repo Code of Conduct
Default position is that “trading to fail” is unacceptable, accidental fails should be avoided

62. QUESTIONS

63. Closing remarks www.LMMA.org.uk
Ian Mair: Chair, London Money Market Association

64. Cleared Term DBV
23 July 2013