Bank opens up money market dealing

Sweeping reforms will end the discount houses' special status
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The Independent Online
The Bank of England yesterday announced the biggest reform for more than a century in the way that interest rates are set, marking the end of the privileged position of the City's seven discount houses.

The bank's dealings in the short-term money markets are to be opened early next year to a wide range of banks, building societies and securities firms of UK or continental ownership.

At the same time, gilt repos - debt backed by government bonds - are to become a key part of the bank's daily trading with the market.

The discount houses are specialist banks that have traditionally had a monopoly on daily dealings in bills of exchange with the Bank of England. Trading in the bills is used to control interest rates and signal changes in the cost of borrowing.

The reforms, scheduled for early next year, will restructure London's sterling money markets in line with proposals expected to be adopted for the market in euros when the single currency is in operation.

However, Ian Plenderleith, an executive director of the bank, denied the restructuring in London was prompted by the single currency or the discussions under way at the European Monetary Institute on how to set interest rates after monetary union.

"That's not our main motive," he said.

Mr Plenderleith said there were advantages in bringing the UK structure into line with the Continent, whether or not Britain joined the single currency. After the reforms, the London money markets would be "state of the art" and the bond markets would be "absolutely at the forefront" in world terms, Mr Plenderleith said.

He said the driving force for change was rapid evolution in the City, especially the mushrooming growth of the pounds 15bn-a-day gilts repo market, where pounds 60bn of repos are currently in force.

The bank will continue to use the traditional bill market operated by the discount houses. But from next year, changes in interest rates will be signalled by a move in repo rates rather than the traditional method of altering the rates at which the bank deals in the discount market.

The bank is also abandoning its insistence that gilt-edged market makers are established as separate firms, known as Gemms, and instead will allow them to be merged into their parent groups' balance sheets.

Gilts repo dealers will sign a private contract with the bank and there will be no published list.

There are to be changes in the money market dealing timetable during the day and new arrangements for clearing banks that need overnight loans. The discount houses' obligation to underwrite the weekly Treasury bill tender will be dropped.

The discount houses have been given a decade of quiet warnings by the bank that their market will be opened up.

They have already diversified into other financial specialisms and some have moved into the gilts repo market. Cater Allen, one of the leading houses, said: "We believe we will benefit [from the changes]."

Until the reform, however, the houses have retained their special access to the bank's dealing rooms. The value of this privilege has been whittled away in recent years because the clearing banks have become the dominant bill market traders, even though they have had to channel their dealings with the bank through the houses.

In 1994, the bank further eroded the houses' role by experimentally beginning fortnightly, rather than daily, dealings in gilt repos outside the discount market.

The European Monetary Institute is expected to publish proposals in January for the detailed operations of the money market in euros.

According to the bank's discussion document, the plans being drawn up by the European Monetary Institute are "relevant to any further development of the bank's operations whether or not the UK participates in monetary union: the changes proposed in this paper are consistent with the direction and spirit of the proposals currently under discussion at the European Monetary Institute".