The annual Global Funding and Financing (GFF) Summit is gearing up under the banner of “Paving the way for new paradigms”, amid a market dynamic that’s in stark contrast to last year. Eurex Repo’s Frank Gast, Managing Director and Member of the Management Board, and Carsten Hiller, Head of Repo Sales Europe, explain how we got here and what the road ahead looks like.
2023 was punctuated by central bank policies, with market participants closely watching the pace and scale of interest rate rises globally. In Europe, the earlier-than-expected repayment of Targeted Longer-term Refinancing Operations (TLTROs) led to increased funding costs in the capital market and a drop in excess liquidity from record highs in 2022 of €4.7 trillion to some €3.6 trillion at end-2023.
The European Central Bank’s (ECB’s) adjustment of the remuneration cap for non-bank deposits has had a significant impact on European repo markets, said Gast, which has meant that non-banks and new customers have contributed more liquidity to the repo markets on the ECB’s move in 2023 to set the rate on non-bank cash deposits at ESTR-20 basis points (bps).
In addition to this, a further boost to CCP repo came when the Bundesbank stopped paying interest in October. This development of remuneration policy over 2023 led to even greater interest in CCP repo on the part of public authorities and for the first time in many years. Cash-driven repo transactions, especially those cleared through a CCP, attracted significant attention, said Gast.
He was keen to point out however that this spike in cleared repo volumes goes beyond central bank policies, and Eurex Repo is growing faster than the overall market in this segment. This, he noted, is due to a number of product developments as well as sales initiatives such as bringing the buy-side on board and diversifying the clientele, reviewing business objectives opportunistically, as well as activities on settlement efficiency.
2024 starting position
With the current market environment of increasing interest rates, TLTRO repayments, and further reduction of excess liquidity, there has been a significant increase in trading activities and new record volumes in the cleared repo markets of Eurex.
Total daily term-adjusted volume increased some 70% across all of Eurex Repo’s markets. Average daily outstanding volumes across all markets swelled 63%, resulting in a new record of total cleared volume of about €920 billion in September 2023. When carving out buy-side trading specifically, total traded volume tripled during the same period year-on-year.
Chart 1: Eurex Outstanding per repo segment vs. ECB Excess Liquidity since 2016
In the backdrop to this performance was a wave of collateral coming back into the markets after TLTRO repayments, and one of Eurex Repo’s aims was to bolster liquidity for French, Italian and Spanish government bonds in the special repo segment.
The combination of central bank policies and market sales initiatives meant that collateral cheapened: the spread between the ECB deposit facility rate (DFR) and the GC Pooling ECB basket shrank from about 14 basis points (bps) at the beginning of the year to only about 5-6 bps by end of 2023, while the GC Pooling EXT basket was down even further to 2-4 bps. Meanwhile, the spread between the two main GC Pooling baskets came down from about 10 bps during the first half of 2023 to about 3 bps by year-end.
It is a perfect example of the “crucial role of risk leadership in achieving business objectives during opportune moments”, Hiller noted, adding that these actions increased the capabilities of clients to trade more of this kind of collateral and moreover, broadened the client base.
“We had to have a delicate balance between cash providers and cash takers,” he said. “On the one hand, there was this tightening of spreads with the tendency for collateral to become cheaper, whereby sufficient collateral was available again which had to be refinanced, as liquidity has its price again. On the other hand, there are many cash providers due to the change in the ECB’s remuneration policy as well as buy-side clients who were looking for attractive investment opportunities.”
Chart 2: Spread GC Pooling Overnight ECB EXTended vs ECB basket rates in 2023
New trading and clearing members continue to onboard: in May 2023 State Street chose Eurex as the first clearing house outside the US to centrally clear repo transactions, followed by BNY Mellon in September. In addition to growing demand from financial institutions and supranationals, as well as central banks outside the Eurozone, pension funds have emerged as strong new players. Over the past two years, there has been a steady increase in volumes in this sector.
Among new participants wishing to connect, there is strong interest in the GC Pooling segment. This upward trend is not limited to short-term transactions but extends to longer-term repo transactions spanning up to one year. The GC Pooling segment is attractive in terms of cost of capital, settlement efficiency, and the wide range of eligible collateral available for funding purposes.
Despite the current involvement of commercial banks, national debt management offices (DMOs), central banks, supranational entities, and, more recently, pension funds in Eurex’s repo markets, the aim is to further broaden the range of participants, which will strengthen the market structure overall, Gast and Hiller both noted.
This expansion means the inclusion of entities such as insurance companies, money market funds, and hedge funds. In the case of hedge funds, Eurex has been offering direct access to the clearing house through ISA Direct Indemnified, and the first pilot clients are expected to complete onboarding in Q1-2024.
Summit Peek Ahead
The GFF Summit 2024 takes place in Luxembourg on January 31 to February 1, bringing the industry together to explore how all these underlying trends are rolling out, with a focus on the future of collateral management and emphasis on technological innovation and developments in the context of central bank’s monetary policy and regulation.
The agenda will feature a keynote from the European Central Bank’s Thomas Vlassopoulos, Deputy Director General for Market Operations on Day 1, and opening remarks to help set the tone for Day 2 by Eurex Clearing’s CEO Erik Tim Müller. Other distinguished speakers include Commerzbank’s Christoph Rieger along with the German Finance Agency’s Martin Nazary, who will participate on a panel asking and answering where European markets are headed.
And in a closed-door fireside chat, Laura Klimpel, General Manager at DTCC, will be in conversation with Brian Ruane, Senior Executive Vice President & Executive Committee Member at BNY Mellon to discuss latest developments of mandatory clearing for UST.
Under the 2024 theme “Paving the way for new paradigms”, discussions will unfold around lending, liquidity practices, and the pivotal role of cloud technologies and artificial intelligence in shaping transformation across businesses and financing markets. Save your seat and register on the event website.
This article was sponsored by Eurex Repo