Analysis and Evaluation of the Eurex Repo Market Model

Diplomarbeit von Monika Gruber

Abstract:

The first cross-border merger of exchanges in Europe, in 1999, happened even across the borders of the EU when the national derivatives markets of Germany and Switzerland created Eurex. In 2000, Euronext, the second big merger project, became reality. The Exchanges of Amsterdam, Paris and Brussels created a new joint platform with corporate structure. Norex, Virt-X, Newex are further merger projects. During the last decade, not only the institutional framework of exchanges has changed, but also the popularity of different products that are traded on the new platforms. Currently the derivatives market, in particular the trading with repurchase agreements, experiences major growth in Europe as well as in the U.S. The Eurex Repo platform observes a steady increase of outstanding volume, due to the fact that Eurex Repo is the only electronic market that offers repo transactions with the shortest possible term of just one night (overnight repo transaction).

The goal of this paper is to analyse and to critically assess the Eurex Repo market model mentioned above, which is currently treated as the most efficient and successful trading platform for derivatives, with a specific focus on repurchase agreements.

Chapter 2 aims to give answers to the following questions: What is a repurchase agreement? Which are the characteristics of repo markets in general? Which risks are associated with repos and how does the pricing of repos work? Which other instruments for liquidity management do exist for banks?

The purpose of Chapter 3 is to give an overview of the derivatives market in general, past business methods, the intermediating role of banks and exchanges, and the dynamic development of the derivatives market. In addition, the Eurex market model will be described, as well as competing market players in Europe and the U.S.

In Chapter 4, the main focus is put on the examination and evaluation of the Eurex Repo market model in order to investigate the key drivers in this model. Considering Eurex’ expansion to the U.S., where the originally European exchange is competing with the major North American exchange CBoT since February 2004, and the advance of Eurex’ main competitor Euronext, the future perspectives for the Eurex Repo market model will be explored.

Table of Contents:

	INDEX OF TABLES	III
	INDEX OF ILLUSTRATIONS	IV
	ABBREVIATIONS	V
1.	INTRODUCTION	1
2.	THE NOTION OF „REPURCHASE AGREEMENTS”	3
2.1	DEFINITION AND CHARACTERISTICS OF THE „REPURCHASE AGREEMENT”	3
2.2	COLLATERAL	7
2.2.1	T-Bonds and T-Notes	9
2.2.2	T-Bills	10
2.2.3	Pfandbriefe	10
2.3	THE PRICING OF REPOS	12
2.4	THE RISK ASSOCIATED WITH REPOS	15
2.5	THE ADVANTAGES OF REPOS	17
2.6	DIFFERENTIATION TO OTHER INSTRUMENTS	18
2.6.1	Securities Lending and Borrowing	18
2.6.2	Sell/Buy Back Agreements	18
2.6.3	Lombard Loan	18
2.6.4	Interest rate swap	19
3.	THE EUREX MARKET MODEL	20
3.1	THE ROLE OF FINANCIAL MARKETS AND FINANCIAL INTERMEDIATION	20
3.1.1	OTC Trade versus Exchanges	22
3.1.2	The Derivatives Exchange	23
3.2	THE HISTORICAL DEVELOPMENT OF THE EUREX	26
3.3	THE CURRENT MARKET MICROSTRUCTURE	29
3.3.1	Structural Features	29
3.3.2	Products	32
3.3.3	Settlement and Clearing	32
3.3.3.1	Eurex Clearing AG	32
3.3.3.2	SIC Swiss Interbank Clearing	35
3.3.3.3	SISSegaInterSettle AG	38
3.3.4	The Eurex Fee and Pricing Model	39
3.3.5	The Development of the Trading Volume	41
3.4	INTERNATIONAL COMPETITION	42
3.4.1	Europe: Euronext, Newex, Norex	42
3.4.2	United States: CBoT & CME	44
3.4.3	The Global Trend	44
4.	THE EUREX REPO MARKET MODEL	46
4.1	THE CURRENT MARKET MICRO STRUCTURE	47
4.1.1	General Conditions for Participation in Eurex Repo	47
4.1.2	Requirements for the Use of the Eurex Repo Trading Platform	48
4.1.3	Rights and Obligations of Participants on Eurex Repo	49
4.1.4	Trading Hours and Trading Calendar	50
4.1.5	Trading Procedures	51
4.1.6	Fees and the Repo Rate	56
4.1.7	Collateral	60
4.1.8	Settlement and Clearing	62
4.2	LEGAL FOUNDATIONS FOR THE EUREX REPO SYSTEM	64
4.3	MARKET SURVEILLANCE	66
4.4	EUREX REPO MARKET PRACTICES	67
4.5	CRITICAL FACTORS FOR THE EUREX REPO MARKET MODEL	69
4.6	FUTURE OUTLOOK FOR THE EUREX REPO MARKET MODEL	73
5.	CONCLUSION	77
6.	APPENDIX	79
7.	BIBLIOGRAPHY	93