Clearing the way for the next phase of Australia’s repo market development

Several forces are currently heightening market participants’ focus on central clearing of Australia’s repo market. One is that the market’s size, structure and usage have evolved, making the widely accepted benefits of improved liquidity and price discovery, and minimisation of systemic risk, increasingly difficult to ignore.

Another is a global shift in market settings. In the US, regulators are mandating central clearing of Treasury repo transactions¹ from next year, prompting markets with voluntary clearing frameworks, such as the UK, to reassess their own approaches². This has also catalysed local conversations about the future trajectory of Australia’s repo market and optimal market design.

As the Australian market matured, and amid renewed industry engagement, the Council of Financial Regulators (CFR) launched a public consultation last year to reassess the case for central repo clearing³. This arrived more than a decade after the Reserve Bank of Australia’s (RBA’s) initial assessment, which set out the benefits of central counterparties (CCPs) but fell short of recommending it be re-introduced⁴.

Submissions made during the consultation suggest that developments in the intervening period have strengthened the case for change. In particular, participants, including Commonwealth Bank, highlighted the potential for a CCP to improve price discovery, transparency and risk mitigation, as well as supporting a deeper and more diverse repo market.

Russell Simpson, Commonwealth Bank’s Global Head of Securities Financing, says, “We believe central clearing is a very important step in having an efficiently functioning repo market. It has the potential to broaden participation among offshore investors and domestic participants, such as regional banks and super funds and helps position Australia’s government bond market among the most sophisticated globally over time.”

However, the path to implementation isn’t straightforward. As reflected in consultation submissions, the transition raises questions about market structure, costs and coordination. The RBA has indicated that it has no plans to join a bond or repo CCP  and the choice of model, whether sponsored, guaranteed, or both, and service providers are yet to be determined.

Key considerations include whether the roll-out should be phased, how compliance is managed, the inclusion of sovereign institutions, and the current lack of prime banking services . There is also the question of how new infrastructure can be introduced without disrupting the existing bilateral framework. Together, these issues will shape a smooth transition to a scalable, widely adopted central clearing function.

Market evolution and maturity

One historical barrier to central repo clearing in Australia continues to gradually diminish. That is, ensuring that the size of the repo market sufficiently supports the economics of a CCP.

According to the aggregated public data analysed by Commonwealth Bank, domestic volumes across debt and equity securities, lending and repo are moving higher, providing insight into the drivers of market activity and momentum. Commonwealth Bank’s Head of Market Strategy and Rates research, Hamid Yahyaei, points to the rebound in repo market volume since the pandemic, as seen in Figure 1, led by increasing activity in semi-government bonds and their use in repo transactions, relative to the Australian Government Securities (AGS) market.

“We’re seeing the repo volumes and overall market size growing domestically. This is currently concentrated in the semi space, and what’s promising is it means there is appetite.” Yahyaei says. “What needs to follow is scale, and with a larger proportion of these securities being bought and held, improved price discovery and participation in securities lending can open up the market.”

For now, market activity remains largely domestic, with non-resident participation comparatively limited, as reflected in the breakdown in banks and Registered Financial Corporations (RFCs) selling securities (Figure 2). Part of this is “the attraction of deeper, more liquid global markets and a domestic market infrastructure largely built on bilateral relationships,” Yahyaei says.

However, as Commonwealth Bank’s Macro and Rates Strategist, Michael Tang notes, looking more closely at these flows, including non-residents selling securities to banks and RFCs, indicates a “fairly sizeable offshore component”. “Anecdotally, we’re also hearing that there is a lot more offshore participation in semis issuance, reinforcing the offshore connection,” Tang says.

Overcoming structural constraints

As Simpson explains, the amount of issuance also plays a role. “While issuance from AGCBs in isolation may not be large, if we start looking at semi-issuance and what that profile could be in coming years, further growth in the market appears likely.”

“That may put pressure on repo market participants and their balance sheets to provide the financing, which may be less in an uncleared market,” Simpson adds. “If balance sheet caps are hit, it can test market resilience and mean central banks have to step in as the conduit between the marketplace and liquidity.”

Central clearing can help alleviate some of these challenges. In its summary of submissions, the CFR noted that “the majority of respondents said that the netting of exposures against a single counterparty (the CCP) could increase market liquidity by freeing up capacity on participants' balance sheets”.¹⁰

This also has the potential to support broader market participation, should the right clearing model be adopted and prime banking services introduced. The Commonwealth Bank’s submission outlined that under a sponsorship model for clearing bonds and repos, smaller market participants can avoid direct costs and capital requirements associated with clearing membership.¹¹

According to Simpson, growing offshore interest, particularly from major northern hemisphere markets, is also creating settlement inefficiencies given Australia’s time zone and fragmented settlement infrastructure. “It’s another reason why central clearing is becoming more compelling,” Simpson says.

“Currently, participants navigate multiple options, settling trades either through Europe-based Euroclear Bank or ClearStream Bank, or cross-border, back through Austraclear while still adhering to the same timings. Given you can’t settle after the cash payment system closes, this results in blockages towards the end of the day.”

To overcome this, it will be crucial to integrate these systems into a cohesive framework that can operate efficiently across time zones. A significant uplift and centralisation of cash and settlement systems will therefore be needed for efficient clearing of repos and bonds in Australia.¹²

Steps towards central clearing

A signal of the case for a centrally cleared market in Australia is the movements among potential clearing houses. The consultation process also considered the location of the prospective CCP operator.¹³

One is LCH Ltd that is considering a launch in Australia. LCH Group is already active in UK and European markets, with Commonwealth Bank recently becoming a member of RepoClear at LCH Ltd, the CCP clearing service for UK gilt repo trades. Others in varying stages of consideration include Australia’s ASX.

LCH Ltd is among the entities considering an Australian launch. The LCH Group already operates across UK and European markets, with Commonwealth Bank recently joining RepoClear at LCH Ltd, the central counterparty for UK gilt repo transactions. ASX is also reported to be assessing participation.

While the interest from potential CCP operators, alongside elevated focus among market participants, industry and regulators, is a positive sign, many important decisions remain ahead. The benefits, including improved market efficiency, price transparency and access have been broadly discussed. From here, selecting the right infrastructure and model requires careful consideration to bolster this important part of Australia’s financial system.