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TORONTO (Reuters) - Canada's investment dealer community said on Tuesday it picked a TMX Group Inc unit to develop a central counterparty service for a key part of the funding market, a move that could reduce risks and keep markets more liquid in times of crisis.
The Investment Industry Association of Canada (IIAC) said it entered into deliberations on the plan with the Canadian Derivatives Clearing Corp (CDCC), the country's main derivatives clearing house, which is owned by TMX Group's Montreal Exchange.
The clearing service for the fixed-income market will remove counterparty risk from the marketplace, particularly concerning repo transactions, to ensure the funding market can operate in times of stress, said Glenn Goucher, senior vice-president and chief clearing officer at CDCC.
Repo transactions, or repurchase agreements, are deals in which a party sells a security and simultaneously agrees to repurchase it at a given price after a specified time.
"Our banks here in Canada didn't trust each other in terms of their credit worthiness as counterparties. They didn't want to lend to each other overnight and that's basically the grease in the wheels," said Goucher, referring to the mood at the height of the credit crunch.
"When you don't take the credit of your counterparties and arrest the financial system, all of sudden the amount of cash available dries up, lending dries up and you get a complete freeze of the banking system. That's what we're trying to mitigate in terms of this solution."
The financial crisis highlighted "the need for an effective netting facility and clearing house for repo transactions to provide core funding and liquidity for debt markets," Ian Russell, chief executive of the IIAC, said.
The member-based group represents the country's investment dealers. Russell said he expects the clearing house will be set up by the middle of 2010.
IIAC declined to comment on the bidding process.
CDS Clearing and Depository Services Inc was a bidder in the process, a spokeswoman said. A source with direct knowledge of the situation confirmed the third bidder was LCH.Clearnet Group.
Clearing houses are designed to reduce the risk that the party on the opposite side of a trade will fail to settle the transaction. Fears of such defaults caused many over-the-counter markets to seize up during the global financial crisis.
They also allow firms to net out transactions, reducing the amount of funds they need to transfer to one another at the end of the trading day.
CDCC is the issuer, clearing house, and guarantor of equity, index and interest rate derivative contracts traded on the Montreal Exchange, while CDS is a national securities depository, clearing and settlement hub that supports for equity, fixed income and money markets in Canada.
CDS is privately owned by Canada's biggest banks, members of Investment Industry Regulatory Organization of Canada, and the Toronto Stock Exchange.
The move was welcomed by Canada's central bank, which said policies and initiatives that help keep core markets functioning continuously, including in times of stress, promote the overall safety and soundness of our financial system.
"Today's announcement represents a critical first step," Bank of Canada Governor Mark Carney said in a statement.
"Developing a more effective central counterparty framework for repo transactions in Canada constitutes important progress, and the Bank of Canada is pleased to be working closely with industry on initiatives such as this," Carney said.
Editing by Rob Wilson