Finadium: Beyond the Bulge: Foreign Banks and Smaller Dealers in US Repo
The focus on balance sheet and return on capital constraints faced in the repo business by bulge bracket US banks has often drowned out the vitality of foreign and non-bank players. This Finadium research report focuses on the challenges and opportunities faced by foreign and non-bank US repo market participants.
The repo business in the US is often seen as monolithic, but this view hides the diversity of players and objectives of dealers in the market. US repo dealers are sorted into three primary groups: bulge bracket US and UK banks, other foreign banks, and smaller non-bank dealers who have, more often than not, entered the market post-financial crisis. The three groups have different business models, often different regulatory constraints and in certain cases very different clientele.
Foreign banks have always been a fixture in the US repo markets, but the emergence of highly levered non-banks is fairly recent. Foreign banks and non-bank independent dealers have taken advantage of wider spreads in the market as bulge bracket banks stepped back. But there is evidence that this trend may have runs its course as larger banks dedicate more balance sheet to securities financing, pushing down spreads in the process.
The DTCC’s Fixed Income Clearing Corporation (FICC) is driving one of the most important new developments, the Capped Contingency Liquidity Facility® (CCLF), which will alter market structure and the flow of liquidity and collateral in US markets. All market participants will feel the impact of the CCLF, but smaller non-bank dealers may be most affected on a daily basis. CCLF requirements are expected to go live in November 2018.
This report should be read by repo market participants across the sell-side and buy-side and by financial market participants more broadly. Our discussion of foreign and smaller non-bank dealers is relevant for directly impacted firms, competitors, clients, and anyone interested in US repo market liquidity. While this used to be a small audience, the introduction of the Secured Overnight Financing Rate (SOFR) means that repo liquidity has further implications for pricing and stability in other financial markets.
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