‘How the mighty have fallen’
This statement can be aptly applied to the long-end EUREX-LCH basis on the EUR curve which has seen the 30y point on curve fall from around 3.5bps in March 2018, to almost flat earlier this year. It has now been quoted as below zero.
This can, perhaps, be driven by significant receiving of the longer end of the curve from traditionally long-only asset managers and pension funds who have to receive rates. By receiving in EUREX, they obtained at better level, and therefore the subsequent hedging by dealers to get out of positions in EUREX further pushed the basis level even lower.
The recent fall in CME-LCH basis for USD rates, and the sharp rally in market, brings in to focus what the next path for EUREX-LCH basis is.
Research conducted by the Cassini product team tries to answer this by looking at various factors which can impact the path.
Impact on basis
Market Expectations of Rally –
Recent press coverage from ECB sources and market expectations of a significant action by ECB in September calls for market to see a rally as we head into the meeting.
More receiving happening at LCH due to more liquidity and higher volumes going through. Further, receiving in EUREX offered better risk reward at higher basis levels but at negative, it all boils down to liquidity.
Brexit Uncertainty and No-Deal –
In a no-deal scenario LCH still is recognised by ESMA as a temporary equivalent CCP upto March 2020.
General volumes and risk transitioning should move the basis lower. Structurally, the risk at LCH is more receiver swaps (dealers who paid to corporates’ to hedge corporate debt received from LCH) and moving these to EUREX will push the basis even lower.
LCH Methodology Parameter Update –
Increases the margin requirements.
Even though the change increases the margin requirements, it just brings the margin requirements back in line with what they had historically been, hence shouldn’t impact the flow.
Depending how the above top two factors play against one another over the next few months will decide how the basis evolves.
Even though the choice of CCP depends on liquidity, basis and slippage, we have increasingly seen clients look to understand the margin and funding implications of moving from one CCP to another especially given different methodologies, portfolio margining and clearing fees.