The European Securities and Markets Authority (ESMA) issued a research piece on shadow banking published in its recent report on trends, risks and vulnerabilities (TRV).
The piece provides a stock-take of the multi-trillion€-large market for securities financing transactions (SFTs) in the European Union and firms’ use of collateral haircuts. ESMA’s research aims at understanding the level and the calculation methodologies of haircuts used in the EU by SFT market participants.
As one of the main sources of liquidity and high-quality collateral, SFTs are an essential component of the EU financial system. EU SFT markets are very large, with the value of collateral used in SFTs amounting to several trillions of Euros. To cover for risks related to the characteristics of the collateral and counterparty creditworthiness, firms apply a discount, known as haircut, to the value of collateral.
However, haircuts may change over time to reflect the evolution of market conditions and can contribute to pro-cyclicality and financial instability by reinforcing asset price movements. The data available on haircuts is sparse and little is known of current market practices. Public authorities’ analysing the risks in SFT markets are hampered by the lack of granular data, including in the EU, until the reporting obligation under SFT Regulation will start.
The EU Regulation on Transparency of Securities Financing Transactions and of Reuse (SFTR) is part aims at reducing financial stability risks arising from shadow banking activities, including SFTs.