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Steep increase in the Eurex-LCH basis – what’s going on? Opportunity for fixed receiver swap clients!

Release date: 12 Nov 2018 | Eurex Exchange, Eurex Clearing

Steep increase in the Eurex-LCH basis – what’s going on? Opportunity for fixed receiver swap clients!

By Eurex Clearing Board Member Matthias Graulich
Matthias Graulich, Member of the Executive Board, Eurex ClearingZoom

Matthias Graulich, Member of the Eurex Clearing
Executive Board

In my last blog on euro clearing, I wrote about buy-side execution costs and that execution prices both in terms of bid-offer spread as well as the basis reached the same level as execution prices for LCH cleared euro swaps. While the bid-offer spreads are still extremely competitive (same spread and size quoted for Eurex and LCH euro swaps) we observed a steep increase in the basis for euro swaps between LCH and Eurex Clearing during the last few weeks. But let me point out: I cannot see a fundamental reason for this development. I think the development is encouraging for fixed receiver clients to take advantage of a significantly better price at Eurex.

Theoretically, the main driver for the basis is the existing or expected balance of client demand for payer and receiver swaps for a specific CCP driving the ability for dealers to run balanced books.

Let’s have a look at the client balance chart for Eurex Clearing – we can see that the balance is broadly unchanged for swaps up to a 15 year maturity and it improved significantly for swaps over 15 years. Both charts show that client demand is fairly balanced – for maturity over 15 year almost perfectly balanced – so no signal of the frequently used claim that “Eurex had only directional flow”. Nevertheless, despite these facts, the basis moved up again.

If the reason is not in the existing client balance, it might be driven by the expectation of a future imbalance driven by fixed payer clients – traditionally banks and asset managers. Cliff-edge Brexit expectations might play a role as in particular EU27 banks are assumed to run net fixed payer books; in case of a cliff-edge Brexit end of March there would be significant pressure to migrate into the EU27.

However, looking at the generic balance below, I’m convinced that there is significant flow from fixed receivers within the EU27 – typically insurance firms and pension schemes – to balance that payer demand. Additionally, it is worth pointing out that the recent statements of the EU Commission should significantly reduce the risk of a cliff-edge Brexit from a CCP perspective – another aspect that there is no sustainable reason for a basis increase.

In summary, there should be no fundamental reason – neither in the existing nor expected balance – for an increased basis. The current situation should be encouraging for fixed receiver clients to take advantage of the basis by receiving a higher rate and correct this anomaly.

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