United Kingdom: Extended-Collateral Long-Term Repo

As strains in the short-term funding markets emerged in the second half of 2007, the Bank of England created the ELTR operations to ease liquidity pressures (Bank of England 2007c). The Bank of England explained the purpose of the ELTR operations in a consultative paper (Bank of England 2008k):

By shifting the composition of its open market lending away from the one-week maturity and towards the three-month maturity, the Bank has helped to provide time for banks, and the authorities, to address the problems underlying market stress. And by extending the range of collateral eligible in its three-month repos, the Bank has assisted commercial banks in financing assets that had suddenly become illiquid.

The Bank of England maintains an operational framework for implementing its monetary policy decisions known as the Sterling Monetary Framework (SMF) (Cross, Fisher, and Weeken 2010). The Bank never refers to specific legislation in any of its discussion of the SMF, and research could not determine legislation that narrowly authorizes the programs in the SMF. The Winters Review, which analyzed the Bank’s approach to liquidity provision, never mentioned legislation or statutory authority, instead focusing on the wide range of authority vested in the Governor of the Bank (Winters 2012). Therefore, it seems likely that the Bank is relatively unrestricted in its power to implement lending programs.

Open market operations (OMOs) form part of the SMF, along with reserves and operational standing facilities (Cross, Fisher, and Weeken 2010). Since the creation of the ELTRs were only an adjustment of the regularly scheduled OMOs, they did not require additional legislation or external approval.

The Bank of England added further liquidity insurance operations as the Global Financial Crisis deepened. It created the Special Liquidity Scheme (SLS) in the aftermath of the collapse of Bear Stearns (US) in March 2008. The SLS sought to improve the medium-term liquidity of banks and building societies by allowing them to swap high-quality, but temporarily illiquid, mortgage-backed and other securities (Fisher 2009).

After the demise of Lehman Brothers, an American investment bank, in September 2008, the Bank of England created two more programs. In September, the Bank of England and other central banks started overnight US dollar repo operations due to “poor liquidity in dollar inter-bank markets” (Fisher 2009). It initiated the Discount Window Facility in October 2008, which is a permanent bilateral liquidity insurance facility that allows institutions to perform asset swaps of eligible collateral for government securities (Fisher 2009).

The ELTR operations functioned under the Bank of England’s Sterling Monetary Framework (Bank of England 2007d).

The ELTRs initially began as a monthly single-good auction, in which institutions could borrow central bank reserves against a single pool of eligible collateral (Frost, Govier, and Horn 2015). The ELTRs replaced the three-month maturities at the regularly scheduled monthly OMOs (Bank of England 2007d).

On the day of the operation, eligible counterparties typically had a 30-minute window to submit their bids, with only ten bids allowed (Bank of England 2007d). From there, the Bank of England would rank counterparties’ bids in descending order by bid. The highest bids were accepted first, and lower bids would be accepted until all bids had been accounted for, or the amount of the ELTR had been exhausted. Successful bidders paid what they bid (Frost, Govier, and Horn 2015).

In order to be an eligible counterparty for regular OMOs from the Bank of England, an institution had to be either a bank or building society eligible for the reserves scheme, or a bank, building society, or securities dealer “authorised under the Financial Services and Markets Act 2000 that [was an] active intermediar[y] in the sterling markets, subject to standards of prudence and risk” (Bank of England 2008a).^FA building society is a financial institution owned by its members that provides mortgage loans and savings accounts. The ELTRs were available to the counterparties eligible for regular OMOs (Bank of England 2007c). In October 2008, the Bank of England said in a consultative paper that it did not anticipate changing the eligibility criteria for counterparties (Bank of England 2008k).

The Bank of England exchanged central bank reserves for less liquid eligible collateral in the repo operations. There was no set overall size for ELTR operations.

The first ELTR drawing in December 2007 offered GBP 10 billion (Bank of England 2007c). The Bank of England adjusted the ELTR size when needed, peaking in September 2008 at GBP 40 billion (Bank of England 2008g). The smallest ELTR occurred after the announcement of the Special Liquidity Scheme in May 2008 with an offering of GBP 5 billion (Bank of England 2008d). This ELTR drawing and two subsequent GBP 5 billion auctions were heavily oversubscribed. Eligible counterparties bid for more than double the amount the Bank offered. Additionally, Lehman Brothers collapsed in September 2008, causing the Bank of England to increase the ELTR to GBP 40 billion, which was still oversubscribed. Participation declined after the initial GBP 40 billion ELTR drawing, and the remaining ELTR drawings were undersubscribed on average. (See Figure 1 for this dynamic.)

Source: Bank of England 2010.

The Bank of England placed limits on individual firm usage of the ELTRs. At the creation of ELTRs, when they were a part of the regularly scheduled OMOs, a counterparty could only place bids of up to 10% of the total size of OMO on offer, across all maturities (Bank of England 2007d). As the Bank of England increased the frequency of ELTRs in the aftermath of the Lehman Brothers collapse, the maximum total size of bids from a single counterparty increased to 20% of the funds on offer (Bank of England 2008g).

The ELTRs did not charge a penalty rate, since earlier attempts in the fall of 2007 to include a penalty rate in some bank programs had led to zero usage (Cheun, von Köppen-Mertes, and Weller 2009). The Bank of England accepted the highest bids first and then bids at successively lower prices until the entirety of the drawing was allocated, with each bidder paying its own bid (Frost, Govier, and Horn 2015).

In September 2008, the Bank of England established that the minimum allowed bid for future ELTRs would be the overnight index swap (OIS) rate (Bank of England 2008g). In October 2008, the Bank amended the minimum bid rule. The OIS rate remained the minimum bid allowed for bids against collateral usually allowed in short-term OMOs. Bids against the newly expanded set of eligible collateral, which was anything not eligible for regular OMOs, would face a minimum bid of 50 basis points higher than the OIS rate. Bidders were required to tell the Bank of England which types of collateral they were holding against their bid. If they did not, the Bank of England would assume it was the wider type and impose the higher minimum bid. Bids against the two sets of collateral competed for the same ELTR drawing, rather than separate auctions. If submitted bids were below the minimum rate, they had to be amended or were cancelled (Bank of England 2008g).

Prior to the Global Financial Crisis, the Bank of England only accepted highly rated sovereign and supranational debt as collateral in its operations (Breeden and Whisker 2010). Specifically, this included:

Gilts (including gilt strips), UK government foreign currency debt securities, sterling Treasury bills, Bank of England foreign currency debt securities, and certain sterling and euro-denominated securities issued by EEA (European Economic Area) central governments, central banks and major international institutions where the issuing entity is rated Aa3 or higher by two of the three major ratings agencies (Bank of England 2007a)

In the first (and failed) iteration of the expanded OMOs, the Bank of England expanded this eligible set of collateral to include private-sector securities, AAA-rated residential mortgage-backed securities (RMBS), non-securitized prime mortgages, and others (Cheun, von Köppen-Mertes, and Weller 2009).

The creation of ELTRs expanded the original eligible set of collateral for OMOs again to include AAA-rated (RMBS) and asset-backed securities, backed by credit card receivables, AAA-rated US GSE debt, and AAA covered bonds (Cheun, von Köppen-Mertes, and Weller 2009). The securities could be denominated in sterling, euro, US dollars, Australian dollars, Canadian dollars, Swedish krona, Swiss francs, or Japanese yen (only for Japanese Government Bonds) (Bank of England 2007c).

In the aftermath of the Lehman Brothers bankruptcy, the Bank of England further expanded the eligible set of collateral to include AAA-rated ABSs of corporate and consumer loans, some types of asset-backed commercial paper, as well as the new bank bonds covered by the Bank of England’s guarantee scheme (Cheun, von Köppen-Mertes, and Weller 2009). (See Appendix A for a deeper description of the eligible collateral expansions.)

The Bank of England announced in December 2007 that three-month repos against the wider set of collateral allowed would be margined separately from other OMOs.^FAdjusted collateral value (post-haircut) = collateral value/margin ratio (Bank of England 2007d). The margin ratios for ELTRs depended on both the type of collateral and the terms of the underlying collateral (see Figure 2 for an example margin ratio table). As the Bank of England adjusted ELTRs by increasing the size and eligible collateral set, it would similarly update its margin ratios at the end of market notices. The Bank of England also added 3 basis points to margin ratios for securities denominated in non-sterling currencies to allow for currency risk (Bank of England 2007d).

Before the Global Financial Crisis, the Bank of England conducted regular OMOs at three-, six-, nine-, and 12-month maturities. The Bank of England expanded the eligible set of collateral and the size for the three-month maturities, creating the ELTRs (Bank of England 2007c).

There were no further notable conditions on ELTR funds.

Initially, the Bank of England stated that it intended to offset the additional reserves provided by the ELTRs by reducing the size of its weekly short-term repo operations. The initial market notice for the ELTRs mentions the possible need for issuance of Bank of England sterling bills to account for the increased liquidity (Bank of England 2007d).

The ELTRs provided a significant amount of liquidity—especially in the aftermath of the Lehman Brothers collapse—and created more central bank reserves than banks could use. This led the Bank to halt its short-term lending operations, as it could no longer sterilize them. To drain these excess reserves from the market and limit the impact on monetary policy, in October of 2008, the Bank of England created the one-week Bank of England bill (Fisher 2009). This new instrument was a non-monetary liability of the central bank that it offered weekly and with a maturity of one week. At their peak on January 8, 2009, the Bank of England issued over GBP 100 billion of one-week Bank of England bills (Cross, Fisher, and Weeken 2010).

In the autumn of 2007, the Bank of England announced four term-repo auctions for funds of three-month maturities, with a wider than usual set of collateral eligible. These auctions included a penalty rate of 100 basis points above the Bank Rate, which led to zero bids (Cheun, von Köppen-Mertes, and Weller 2009; Fisher 2009). When the Bank of England announced the ELTRs in December 2007, it removed the penalty rate and widened the set of eligible collateral even further (Fisher 2009).

The original announcement of the ELTRs on December 12, 2007, presented the expanded operations as a joint effort between the Bank of England, the European Central Bank, the Federal Reserve System, and the Swiss National Bank. Additionally, the original announcement links to similar programs by the Bank of Japan and the Swedish Riksbank, but the Bank of England does not appear to have directly coordinated with these two central banks in a similar fashion to the others (Bank of England 2007c).

The Bank of England routinely provided market notices which described design changes to upcoming ELTR operations. The Bank of England announced the size of ELTRs the Friday before operations (Bank of England 2008h).

When the Bank announced the failed auctions in the autumn of 2007, it stated that these operations would attempt to “alleviate the strains in longer-maturity money markets” (emphasis added; Bank of England 2007c). However, when the Bank unveiled the first ELTR operations, it said that the purpose was “to address elevated pressures in short-term funding markets” (emphasis added; Bank of England 2007d). It is unclear why the phrasing changed in between iterations, as the Bank mainly removed the penalty rate in announcing the ELTRs.

The Bank of England announced the results of ELTRs approximately 25 minutes after the 30-minute window for bids closed (Bank of England 2007). The reported results included the total size of bids received, the cover ratio, the lowest and highest accepted rates, the weighted average accepted rate, the tail length, and the proportion of the total ELTR allocated to bids at the lowest rate (Bank of England 2010).

The Bank of England has not released individual participant details.

The Bank of England held four term auctions in September–October 2007 which featured adjustments to the regularly scheduled OMOs, such as an expanded set of collateral. However, no bids were placed by commercial banks during these four auctions, due to a penalty rate of 100 basis points above the Bank Rate, and stigma concerns. Institutions feared that their participation in the term auctions would become public and they could potentially collapse and face nationalization, as was the case with the mortgage lender Northern Rock in September 2007 (Cheun, von Köppen-Mertes, and Weller 2009).

In response to these issues, the Bank of England removed the penalty rate when initiating the ELTRs. Additionally, the Bank of England reassured commercial banks that their participation in the ELTRs would not become public when the first two auctions announced were fully subscribed (Cheun, von Köppen-Mertes, and Weller 2009).

The initial announcement of the ELTR operations only provided for two auctions of ELTRs but stated that extensions could occur depending on market conditions (Bank of England 2007c). The Bank of England periodically extended ELTRs until the creation of ILTR in June 2010 as a permanent facility in the Sterling Monetary Framework (Frost, Govier, and Horn 2015).