The London EuroDollar market in the 1960s and 70s – Fed Funds and Clearing Funds

Having been bored to tears with my description of Fed Funds and Clearing House Funds, I am now going to subject you to a treatise on how this affected the London EuroDollar market.

I have tried to explain how you could convert Fed Funds into Clearing Funds and vice versa – basically there was a one working day interest allowance that accrues to a Fed Fund balance when it is converted to Clearing funds. OK, in English, this means that if you have $1,000,000 of Fed Funds and you exchange them for Clearing Funds with a current interest rate of 5% you get $50,000 (being 5% interest for one year) divided by 360 (the US always uses 360 as a year base whilst the UK always uses 365) so you would transfer away $1,000,000 for Fed Funds and receive 1,000,138.89.

Now the interesting thing is that if you did this on a Friday, the interest received would be $138.89 * 3 because the Clearing Funds would require 3 days (Saturday to Monday) to become cleared funds.

In the early 60s, banks in London were content to deal in Clearing funds and not concern themselves with Fed Funds as no-one (except for a small number of US banks) had access to such things in the normal course of business. Step forward to the influx of regional US banks from about 1965 onwards – more specifically to the arrival of National Bank of Detroit (NBD) onto the London scene. Now NBD were in London for one single reason – to tap the EuroDollar market for funds to repatriate back to Detroit for internal use. They quickly worked out the problem with trading in London, vis-a-vis Fed Funds, which is what they were after. So, if they borrowed money on a Friday, they would pay 3 days interest until Monday but would only get 1 days Fed Funds interest from Monday to Tuesday. Are you beginning to see how this works? But, and it is a big but, if they borrowed Clearing funds in London on a Thursday, they only paid one day’s interest but got Fed Funds for the three day weekend. Rapidly, they started to bid up on the Thursday market and everyone cottoned onto the weekend so the  borrowers dropped out until the price plummeted.

E.G. Day to day funds are 5%.
Mon – Tues = 5%
Tues – Wed = 5%
Wed – Thur = 5%
Thur – Fri = 15%
Fri – Mon = 1 5/8%

BTW, the NBD gained a nickname in the market. They were known as the “Flying A**hole” for some reason!

The problem got even more complicated. If a one month trade started on a Thursday but finished on a “standard” day of the week, the rate would be inflated by the 3 day effect of the Thursday – Friday and likewise, if a period started on a Friday and ended on a “standard” day, the rate would be reduced because of the weekend rate effect. This caused great complications and there were dealers out there who spent their lives working out rates for strange periods in the hope of catching people out. In fact, some years later, I wrote a computer program for my bank that did all of the calculations. Until everyone else woke up to trading desk software, this gave us a great edge in the money markets.

I left the market in 1985 so I am not sure when, or if, this pattern dies out.

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