Should the European repo market clear and settle only in central bank money?

Abstract

One of the threads in the regulatory discussions that have been taking place in Europe in the wake of the Lehman crisis has been about strengthening the financial market infrastructure. Attention has turned to the issue of whether payments by so-called financial market infrastructures should be made in ‘central bank money’ (CEBM) rather than ‘commercial bank money’ (COBM). This paper looks at the roles of CEBM and COBM in the clearing and settlement of fixed-income securities in Europe. CEBM is seen as a risk-free settlement asset. The problem is that most institutions wishing to make payments do not have access to central bank accounts and many institutions that do have access do not necessarily think it economic or worthwhile to open an account. But, most importantly, few central banks offer cross-border access (a major exception being the European Central Bank within the eurozone) and none offer foreign currency payments. All developed economies therefore use CEBM and COBM in tandem, but the vast bulk of payments are made in COBM. In order to aid an understanding of the complex interaction of CEBM and COBM in the clearing and settlement of repos in Europe, the paper maps the flow of money and securities in central counterparty-cleared repo business.