ICMA has published a report on the European repo market at year-end 2017,
based on market data and interviews with market participants (sell-side and buy-side) to provide a brief analysis of the way the market performed and the underlying factors that affected it. The period around year-end has always been a challenging time for short-term funding markets as banks close their trading books in order to reduce balance sheet, however monetary policy and various regulatory initiatives (including Basel III reporting requirements) have combined to increase year-end pressure on the market.
The year-end 2016 saw extreme volatility in the European repo market, when a shortage of high quality collateral (mostly European sovereign bonds) resulted in unprecedently low repo rates and severe market dislocation for dealers and fund managers in the short term funding and collateral liquidity market. The 2017 data shows that while there were
significant year-end effects on repo rates and on liquidity, particularly affecting the ability of the pension and insurance funds to manage their cash and collateral requirements over the year-end period, these were markedly less severe than in the previous year.
The report identifies several possible reasons for the 2017 year-end being less disorderly
than 2016. In general the market was more aware and therefore better prepared (and
positioned) after the dislocations of the previous year. Improved National Central Banks
lending facilities for Public Sector Purchase Programme holdings also appear to have been a factor. More bank balance sheet committed to the repo market during 2017, with improved netting efficiency and increased profitability, certainly helped in the long-term run-up to year-end.
The 2017 year-end, though not as dramatic as 2016, continues to highlight the vulnerabilities of a market that is dependent on banks’ balance sheets, and that remains highly sensitive to regulation. It also needs to be remembered that year-end is a predictable and broadly anticipated event, for which the market can prepare itself. It therefore remains an open question going forward as to how the repo and collateral markets would respond in the face of an unexpected shock.