The European Repo and Collateral Council (ERCC) of the International Capital Market Association (ICMA) released the results of its 44th semi-annual survey of the European repo market.
The survey, which measured the amount of repo business outstanding on 8 December 2022, from the returns of 61 financial institutions, sets the baseline figure for European repo market size at a new high of €10,374 billion ($11.1tn) up by 7.2% from €9,680 billion in the June 2022 survey and an increase of 12.8% year on year. ICMA noted that some of these increases reflected new participants into the survey.
The key developments impacting the survey in the six months since the previous survey were the market turmoil in September and the end-year winding-down of dealers’ balance sheets.
The market turmoil, arising from uncertainty over the rate and extent of central bank interest rate increases and the shock of the UK mini-budget, occurred against a backdrop of rising activity in the repo market, with an incongruous combination of increased cash-driven trading in response to rising and positive interest rates and increased securities-driven trading in the face of continued collateral scarcity.
The market turmoil fueled an exceptional surge in trading as dealers sought to cover short positions against further interest rate increases and against bond futures, and investors sought safe-haven assets. These events helped to boost demand for German and, to a lesser extent, other core eurozone government securities. However, the sell-off of UK gilts by LDI pension funds may have sapped subsequent activity in the gilt repo. This sell-off was partly the result of constraints on the intermediary capacity of the repo market and its ability to refinance pension fund holdings.
The events in September took place at a time of increasing concern about the capacity of dealers to intermediate repo flows at the end of the year in the face of regulatory and other constraints. Year-end is a time when dealers typically “window dress” their balance sheets by shrinking them in order to minimize the regulatory and other costs and consequences linked to end-year balance sheet size. In 2022, such concerns manifested themselves as early as the summer and forward prices implied severe market tightness by the year-end.
In the event, the end-year passed smoothly. This was a result of preparations by the market (both dealers and customers) and supportive action by the authorities (eg the issuance of additional German government securities to be able to lend in order to relieve collateral scarcity and adjustments by the ECB to defer TLTRO repayments).
Market preparations included the usual seasonal increase in longer-term repos over the year-end (increasing the average survey’s term-to-maturity) but also a record number of forward repos. Some forward repos stretched well beyond the year-end but others were the result of breaking up such long-term repos into an initial transaction maturing after the year-end to facilitate netting and a subsequent one to extend the asset-liability management impact of the two transactions.
Balance sheet concerns may also have been behind the seasonal increase in securities lending from repo desks. Securities loans against non-cash collateral can be used to borrow or lend securities without the balance sheet impact of repos.
One unexpected fall-out from increased market uncertainty and the consequent volatility in the price of securities was a contraction in tri-party repo. This cash-driven sector of the repo market had declined for several years in the face of excess liquidity from central bank but had started to revive as monetary policy was normalized and positive interest rates pulled cash back into the repo market. However, concern over rate changes and volatile collateral prices stymied this recovery in the second half of 2022. Collateral price volatility was also reflected in a significant rise in haircuts on almost all types of tri-party repo collateral.
There was one exception to the decline in tri-party repo. This was in some GC financing facilities, which are combinations of CCPs and tri-party collateral management. In contrast to other tri-party repos, GC financing transactions are standardized and interbank. The convenience of standardized products may have become more attractive to banks managing liquidity in an environment of uncertain interest rates. There were further increases in the shares of floating-rate repo in the survey, as would be expected in an environment of rising interest rates.
In an emailed statement, Sabine Farhat, head of securities finance product management at Murex, said: “ICMA is rightly outlining wider industry worries surrounding liquidity conditions in repo markets that took place toward the end of last year. As seen with Credit Suisse recently, having close intra-day monitoring of collateral value becomes quite important. There are longstanding issues around capabilities for liquidating repo collateral in the event of a cash borrower’s default.
“The issue is that securing pre- and post-trade collateral in this market can take time due to highly manual processes. To help overcome some of the challenges outlined by ICMA, market participants first and foremost need to ensure they are operating collateral management in a centralized manner. The availability of collateral is crucial to minimizing costs and creating greater need for sourcing capital efficiently through repo markets.”