In a recent note, the Bank of Canada (BoC) examined whether central clearing of repurchase agreements (repos) provides benefits not only to bank-owned dealers but also to non-dealer market participants in Canadian fixed income markets.

Overall, researchers show evidence that central clearing can be seen as a tool used in coordination between dealers and their clients to manage dealers’ balance-sheet capacity and costs. These costs could be severe in a crisis, and so, going forward, increased central clearing in the Canadian repo market would make the repo market more resilient to stress, acting as a stabilizing force in Canada’s fixed income market more broadly.

It is possible that the ability to centrally clear could be seen by clients as an investment that improves their funding availability during the next crisis, however, there are currently several barriers to more central clearing by clients.

First, set-up costs and systems requirements are currently barriers for some participants. In addition, the benefits of central clearing during normal times from netting may be relatively small in terms of rates, likely on the order of a few basis points, while the benefits during a crisis may be large but are difficult to measure.

Second, many clients are not currently eligible for membership at Canadian Derivatives Clearing Corporation (CDCC), so a new membership model such as the sponsored model seen in other jurisdictions would be needed to include other classes of clients, such as hedge funds.

Moreover, the subset of clients that are currently eligible to centrally clear (i.e., large public pensions) may be among those least in need of improved funding stability in a stress event, as they are among the highest priority clients for dealers due to activity across multiple business lines (underwriting, derivatives, etc.) and have among the highest credit ratings.

“Ultimately the industry will need to coordinate if central clearing is to be expanded. This is because, generally, there is no netting benefit to being the first to join a clearing house, so one cannot expect one entity to join without an assumption that others will. In addition, benefits would be greatest if clearing were expanded to bring together complementary cash lenders and cash borrowers with offsetting requirements of similar maturity terms,” according to the report.