Speech by Benoît Cœuré, Member of the Executive Board of the ECB, at the ERCC General Meeting on “The repo market: market conditions and operational challenges”, Brussels, 14 November 2017
Regulation is forcing market participants to re-examine the extent of their engagement and make more efficient use of their balance sheets. This adjustment process coincides with central banks worldwide adopting a series of unconventional monetary policy measures that have also affected the nature and scope of repo market activity.
Some of these effects will prove temporary, others more permanent. Their full impact can only be assessed in earnest once markets have fully transitioned to their new steady state. From a central bank perspective, it is important to ensure that our own measures do not adversely affect the intermediation capacity of repo markets. Our decision in December last year to also accept cash as collateral in our securities lending facility has proven very effective in this respect. It contributed to mitigating risks of extreme specialness, while preserving the effectiveness of our policy measures in the pursuit of our price stability objective.
At the same time, a high degree of persistence in repo specialness lends support to the idea that the stock of securities already held by the ECB is likely to be a powerful channel through which our measures can help preserve accommodative financing conditions, even after the end of our net asset purchases.
EU CRR, SFTR, LR, LCR Basel III
Policymakers will continue to closely monitor developments in repo markets and financial markets more generally. Some effects can only be thoroughly assessed once the reforms have been implemented more meaningfully, while others may become clearer at an earlier stage. For example, it seems undisputable that regulatory reforms have contributed to temporary volatility in repo market activity on reporting dates.
Specifically, window-dressing behaviour of banks appears a likely unintended effect of regulation. I would therefore encourage further analysis of methods that could help reduce volatility and thereby contribute to a smoother functioning of markets. In this respect, you will have seen in a recently published Opinion of the ECB on, inter alia, amendments to the EU Capital Requirements Regulation (CRR), that the ECB supports the review of the calculation method for the leverage ratio.
I have also previously voiced support as CPMI Chair for implementing the leverage ratio in a way that does not create disincentives for centrally cleared transactions, namely by offsetting the initial margin in the case of derivative exposures related to client clearing.
All these exercises, however, should not be mistaken for tolerance of a relaxation of regulation. Post-crisis reforms aim to curb excessive leverage and reliance on short-term wholesale funding, and for good reasons. This is also why the Financial Stability Board (FSB) has published specific recommendations, including a framework for minimum haircuts for securities financing transactions (SFTs).
The FSB has also assessed the potential financial stability risks related to collateral re-use in SFTs. The latter may contribute to a build-up of leverage and increase interconnectedness among market participants. The FSB concluded that regulatory reforms, in particular the leverage ratio and the liquidity requirements, are important to mitigate these risks.
This means that the implementation of the Basel III reforms will have effects on repo markets, as intended. These might look undesirable from an institution-perspective but they will have system-wide benefits.