Cash has almost become a secondary consideration in the shift to a secured world, and that means collateral is grabbing the steering wheel in driving the market forward. Such a transition means a greater need to mobilize collateral to enable transactions, risk management, and even market making, according to panelists at Clearstream’s GSF Summit.
According to Grigorios Markouizos, Citigroup’s Global Head of Fixed Income Finance, the last three or four years have been marked by the move from an unsecured to a secured world, and the resulting collateral needs “have provided a floor in the size of the repo market, and are generating new growth into it over the last eighteen months”. Still, the last four years have been “traumatic as far as the market and the financing of the market is considered”, noted Eugene McGrory, Head of European Repo at BNP Paribas. “Leverage Ratio has become the main constraint for many institutions, especially in Europe…(and) clearly has an impact on the repo market more so than any other market.”
During “balance sheet intensive periods”, such as quarter-end regulation or reporting periods, there has been continued excess volatility, and even to some degree illiquidity starting to show in the market. “Clearly that’s a kind of concern and worry in the market,” McGrory explained. But there might be light at the end of the tunnel. Though banks are still recording the Leverage Ratio, which makes it a binding constraint, McGrory is seeing some move to a more stress-based capital requirement that is a hybrid between a Leverage Ratio and RWA.
“The market (is) starting to realize that we can’t look at it in one way or another way, and maybe we have to be kind of sensible,” he said “Regulations are there for a reason… the markets overstepped in the past and we are trying to stop that eventuality happening again. We just need to be clever about the way we build the market and to make sure we have a sustainable and liquid market for the many things that are coming in our direction.”
One of those incoming things is the collateralization of the derivatives markets, in which repo practitioners play a vital role in transformation. But panelists rejected the idea that the repo desk is some kind of utility business. Citigroup’s Markouizos was upbeat about the future: “We have had our most profitable year last year, and actually we see a lot of spread in our markets. For the first time in many, many years I can see an upward slope of earnings for my business going forward.”
But it’s hardly a secret that profitability is expected to continue being a struggle, and one of the major implications has been that repo desks are starting to shed clients according to the bottom line. Panelists echoed this concern in an era of squeezed balance sheets, but the response might well provide a boost for the CCP structure in repo, which has been eager to gain acceptance. Richard Déroulède, Head of Trading Equity Finance for Europe at Societe Generale, said that there are aspects of the business that have become vanilla. “Clients are asking for something very simple and cheap. I believe there are going to be evolutions for CCP for this type of business.”
He added that in any discussion of balance sheet constraints, the traditional risk-reward trade off was important to keep in mind: “For many years, balance sheet was largely available, we have perhaps forgotten the reward aspect and we are now coming back on the basic analysis of businesses, which is a risk informed of a reward.”
