Daily Commentary BY THE CURVE TEAM –

Weekly Insights – CLF Removal Implications

13th of September, 2021

Key Updates

Tuesday – Business conditions and confidence for August

Wednesday – Consumer confidence for September

Thursday – Employment for August

CLF Removal

On Friday last week APRA announced the end of ADIs being able to include the Committed Liquidity Facility (CLF) as part of their HQLA by the end of 2022. By the end of 2021 no CLF can be included in the liquidity coverage ratio (HQLA that is used to meet short term obligations, i.e. less than 90 days).

APRA had already indicated such an event was possible and has been reducing the CLF allowance. Since 2018 when the allowance was $248 billion, it has fallen to $142 billion as of 2021. We have also followed Chris Joye’s commentary, which anticipated the removal of the CLF.

The update was largely driven by an increasing supply of government bonds as the federal and state governments have raised funds during covid. The portion of government and semi government HQLA securities are expected to rise to $1 608 billion up from $1 340 billion at the end of 2020. When this amount had been lower, the CLF meant ADIs could include other ADI securities, such as ADI bonds.

ADIs will need to shift at least part of their HQLA from the CLF to government and semi government bonds. Although the current CLF allowance is $142 billion, a smaller amount is expected to flow into government and semi government bonds. NAB expect as low as $50 billion to flow into semis and government bonds, with bloated ES balances (which is included as HQLA) meaning ADIs already have large amounts of HQLA not including the CLF. Indicative of this is ADIs current liquidity coverage ratios, which are around 130%, well above the required 100%.

Investing Implications and Strategy

ADIs have offloaded over $70 billion of government bonds since the RBA started QE. This mitigated some of the effects of QE, but even still QE has resulted in suppressed yields on government bonds.

As ADIs buy government bonds in large volumes (at least $50 billion going off NAB’s prediction) to include as their HQLA, yields should remain suppressed or even head lower. Adding to this, the RBA are expected to maintain QE for at least half of 2022, even if at lower volumes.

As a yield play, government bonds are not the place to be. With the central bank artificially lowering yields they are signalling to investors to go elsewhere, which should be ignored at investor’s perils. For entities regulated to hold such assets though, continued QE and the CLF changes poses a downside risk for yields.

Such entities should consider buying government bonds earlier rather than later, so if yields decline over 2022 they stand to make a capital gain (even if unrealised). Already government bond futures suggested lower yields following Friday’s announcement. It would also free up capital for non-government bond investments, which stand to have higher yields following the CLF changes.

Around 60% of NAB’s recent bond issue was purchased by ADIs. Such a bond can be included as collateral for the CLF, hence the large demand by ADIs. Without this being included as HQLA, demand for such assets will be lower, which should put upward pressure on yields. Further, ADIs will likely need to raise funds to buy government and semi government bonds, which should boost the number of new issues.

Entities that purchase their required government bonds now would then be able to reap the benefits of higher yields in other assets by mid to late 2022. On Friday, senior unsecured bonds saw an uptick of yields following the announced changes. Upward pressure as a result of the CLF should be most acute over 2022.

Josh Stewart

Associate - Money Markets