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38. Could a repo rate benchmark replace LIBOR or EURIBOR?
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The concern that emerged in 2012 over the collusive manipulation of widely-used interest rate benchmarks such as LIBOR and EURIBOR by banks on the fixing panels also served to highlight the chronic underlying problem of dwindling liquidity in longer-term unsecured interbank deposits. What were the sources of rates such as 6, 9 and 12-month LIBOR and EURIBOR, given the thin or non-existent trading in such tenors? The unsecured interbank deposit market had become increasingly illiquid since the 1990s and liquidity vanished entirely during the financial crisis that erupted in 2007. Illiquidity, even more than the manipulation of fixings, called into question the validity of these traditional money market benchmarks. Manipulation can be prevented, but liquidity cannot be invented. Given that liquidity has been migrating from unsecured to secured money markets, the logical question is whether a repo rate benchmark should be substituted for LIBOR, EURIBOR and other unsecured interbank deposit (IBOR) benchmarks.

As a practical matter, it will be difficult to redesign or renegotiate the trillions of dollars of financial contracts currently linked to LIBOR, EURIBOR and other IBORs. And currently there is a fundamental obstacle to the construction of any meaningful interest rate benchmark. Such benchmarks are meant to measure the average cost of wholesale funding to banks. However, heightened anxiety about credit risk has resulted in the tiering of banks in terms of perceived creditworthiness and cost of funding, rendering the idea of any average cost of funding unrealistic.

But even under normal market conditions, a repo rate benchmark would be challenging to construct. Repo rates depend on the credit risk of the repo counterparty, the quality of the collateral and the correlation between the credit risks of the repo counterparty and collateral issuer. In order to minimise the influence of counterparty credit risk, the estimation of an ‘average’ repo rate for a benchmark would require that rates (actual or quoted) be taken from ‘prime’ banks, as they are for IBORs. In order to ensure the quality of collateral and minimise the problem of counterparty-collateral correlation, eligible collateral for the benchmark would have to be government bonds --- except for countries where bail-outs of banking systems have established a strong correlation between governments and banks (‘wrong-way’ risk).

Ideally, repo rate indices should measure the general collateral repo rate (see question 11). However, in the eurozone, diverging perceptions of the creditworthiness of member states has fragmented the euro GC repo market into national segments. Moreover, as a result of the search by investors for safe havens, most high-quality government bonds are specials, trading at idiosyncratic rates reflecting the scarcity of supply for particular bonds rather than the cost of repo funding (see question 12).

The influence of collateral on repo rates is minimal for one-day terms such as overnight, but become increasingly more significant as the term of repos extends. This is reflected in experience to date with repo rate benchmarks, with some overnight repo rate benchmarks succeeding but only one term benchmark showing any promise. Current repo rate indices include:
  • STOXX GC Pooling Indices based on data from the Eurex Repo is a transaction-weighted overnight repo rate benchmark compiled from actual repo rates and volumes over the day on its Euro GC Pooling automatic repo trading system.
  • The GCF Repo Index published by the Depository Trust & Clearing Corporation (DTCC), which operates the CCP for the US repo market, is a family of three transaction-weighted overnight repo rate benchmarks for transactions against US Treasury, Agency and Agency MBS collateral in the inter-dealer brokered General Collateral Finance market compiled from actual repo rates and volumes over the day by the DTCC. This benchmark appears to be successful and a futures contract on the benchmark has been launched by NYSE LIFFE.
  • GovPX owned by BrokerTec (Nex Markets) is a set of observations of overnight and term repo rates for US Treasury and Agency collateral and a transaction-weighted overnight US Treasury repo index published periodically throughout the day.
  • The RepoFunds Rate published by BrokerTec (Nex Markets)  and MTS since December 2012 is a family of three transaction-weighted overnight repo rate benchmarks for repos against French, German and Italian euro-denominated government bond collateral, and a general eurozone benchmark. This novel benchmark is based on a quasi-GC basket of collateral constructed by eliminating outliers from rates on the BrokerTec and MTS automatic repo trading systems.
  • The Repo Overnight Index Average (RONIA) published by the London-based Wholesale Market Brokers’ Association (WMBA) is a transaction-weighted overnight repo rate benchmark for sterling based on DBV (Delivery-by-Value) repos brokered by WMBA members. The emergence of a market in overnight indexed swaps (OIS) against RONIA has begun to establish a swap curve out to one year.
The manipulation of traditional indices such as LIBOR and EURIBOR has made the market cautious about the use of contributions from selective panels of banks. There is a preference for using rates from general sources such as trading venues, CCPs and clearing and settlement systems, which also have the advantage of offering rates on transactions rather than quotes. However, such sources need to have wide market coverage in order to be useful.

Ultimately, the success of any interest rate benchmark will depend upon the degree to which it is correlated with the rates at which banks actually fund themselves.

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