The European Repo Council just published their semi-annual survey of European repo market participants. This is always a great piece of work. There is an overhang to this year’s figures however: is the market snapshot posted an indicator of improvements or a blip in a declining trend?
First off, the ERC’s survey is the best game in town when it comes to assessing a picture of European repo activity. They provide great cross-sections of CCP activity, collateral held, business on tri-party, etc. The data are collected for a single date, which is excellent for a deep dive on that day while less helpful in understanding average volumes across a time period. Really though, the only trouble we’ve had with the survey is understanding double counting among participant books – whose repo is someone else’s reverse repo – and how big does that make the actual repo market? But this is a minor quibble compared to the value of the survey itself.
Our concern today comes from the interpretation of the data compared to what we see as the deep seated regulatory challenges still facing European capital markets. According to the ERC, “The growth in European repo may also be a sign of continuing normalisation of financial markets. Reduced reliance on the ECB, reflected in lower liquidity surpluses and repayments of the 3-year LTROs, is forcing banks back into market. This has been evidenced by tighter funding conditions.” The ERC also acknowledges, as they have many times in the past, that “current and prospective regulation is weighing on the European market.”
We see the biggest issue as the Financial Transactions Tax, which aside from a direct tax on repo that will likely not happen, is almost certain to dampen overall European financial market activity. We need only look to Italy, which saw equity market volumes drop by 50% (!!!) after their recent introduction of an FTT. Or France, which saw sharply decreased FTT revenues than it had projected. In the months in 2012 following their FTT introduction, France raised EUR 200 million instead of the EUR 530 million it had hoped for. Even Hungary, which introduced an FTT in January 2013, saw revenues of less than half the EUR 90 million it once expected. We checked data from the World Federation of Exchanges on trading volumes but they were inconclusive: definitions and markets have changed and Borsa Italiana isn’t reporting, so no grand conclusions are available there. Still, Sweden’s disastrous experience with FTT’s 20 years ago should be remembered. The conclusion for regulators: FTT’s don’t generate the revenues or results that you think they do, and they significantly damage your trading volumes.
There are also disparities between US and European repo markets, something that we think is a sign of things to come for Europe rather than the cyclical recovery cycle that the ERC thinks. According to the ERC, “The expansion of the European repo market would appear to be at odds with reports of several US banks and European banks with large US operations contracting their repo activity during the first half of the year. It is, however, important to distinguish between the two markets in terms of where they are in the cycle of recovery from the global financial crisis and the degree of regulatory pressure to reduce banks’ reliance on short-term money market funding, which itself reflects structural differences in bank funding. The recent growth of the European repo market represents a recovery and return to some form of normality, as evidenced by the declining liquidity surplus at the ECB, rather than an increase in market leverage that might concern regulators.”
We’re all for a growing European repo market. But the facts of still to come regulation, most importantly some form of FTT, are hard to avoid. We think that in full, these regulatory impacts translate into future repo declines on the order of 20% to 40%.
The full European Repo Council survey conducted June 2014 is available here.