Securities Finance Monitor recently spoke with Bertrand Bordais, Global Head of MM Government Bond Repo of the Global Securities Financing team at Natixis. Bertrand shared his views on the European repo markets, upcoming Leverage Ratio changes and global competition.
Securities Finance Monitor: Bertrand thanks for speaking with us. To start, could you tell us how you see the current state of European repo markets?
Bertrand Bordais: We are in a period of relative calm with ample liquidity. During the first weeks of COVID-19, there were pricing discrepancies between peripheral and core govies and some of these were getting quite sizable. Italian repo on term for example was cheaper than German repo (positive double digit spread vs Eonia). We are now more or less back to “pre-COVID-19″ levels. The difference is the implementation of the European Central Bank’s (ECB) targeted longer-term refinancing operation (TLTRO) III that evolved in June 2020 with rates potentially as low as -1%. Starting then, Italian repo came back to levels before COVID and repo spreads are tighter again between € govies.
SFM: How has the impact of central bank’s intervention been on the repo markets?
BB: It is hard to give a precise answer. Compared to last year when you could have seen some volatility on bonds and cheapest to deliver, now central banks have smoothed out that volatility on prices. Central banks are now in the business of avoiding scarcity of funding. That means from a liquidity perspective, intervention is working well, but the market is not the same. EU repo is transforming into a collateral market compared to an arbitrage market.
SFM: What clients are looking for collateral in this environment?
BB: Besides counterparties that are cash rich and want to lend with minimal risk, there are clients trying to get some pick-up on expensive bonds. The problem is that there are fewer and fewer expensive bonds right now. We are largely in a General Collateral (GC) market compared to the past. Currently, the difference between Italian and German bond repo is only a few basis points around ECB deposit rate at -0.50%. There is very little difference between the countries.
SFM: What does other client demand look like for repo?
BB: We saw a sharp increase in term repo demand in April, nearer the start of the COVID pandemic. Some banks were concerned about a cash squeeze and recalled their repo trades with clients to avoid possible liquidity issues. Banks without these same constraints benefitted from an uptick in business. That said, as we are now in September there are no more such worries: both banks and their clients have the balance sheet capacity to refinance positions. This is again the result of the ECB TLTRO III program, as even large consumers of repo cash, such as Italian bondholders, can go to the ECB to hedge their Treasury exposure.
A broader characteristic of the current market is an inability to create arbitrage. When looking at liquidity and spreads between Italian and German bond repo, they are very similar. You can see the difference from between March and June when the arbitrage between high quality and worse quality bonds was attractive across currencies. There could be a nice pick up since FX spreads were wide. In particular, US Treasury holders could make money by accepting bonds in other currencies. This trade has died down, at least for the moment.
SFM: Do similar repo rates across core and periphery countries suggest a greater cohesion in European financial markets compared to pre-COVID-19?
BB: You can only make that argument about repo, so not really. The ECB deposit rate is distorting the EU repo markets. The ECB rate of -50 bps can let market participants borrow cheaper than -50 bps, then give the cash either to the ECB and earn a spread or even buy Italian repo, hence tightening intra-countries’ repo prices. On the contrary, regarding the € cash market, the 10-year BTP/BUND spread went as high as 280bps in March and is still around 150bps.
SFM: Are you expecting an impact to repo from the ECB’s new €750 billion recovery fund?
BB: It had definitely more to do with cash market rather than repo market. Just after the release of the ECB recovery fund mid-March, BTP outperformed Bund by 70bps on a single day! On the repo market side, recovery came instead from June TLTRO III, allowing Italian repo to tighten back to core govies levels. And so far, we just saw core govies repo term prices richening by only a few bps thus coming back to pre-COVID-19 levels whereas we could have expected more appreciation with the huge recovery fund program. Maybe later…
SFM: The US Federal Reserve has made some unilateral changes to the US version of the Basel III Leverage Ratio (the Supplementary Leverage Ratio). What do you think this means for EU regulators?
BB: The move by the Federal Reserve to exempt US Treasuries from the Supplementary Leverage Ratio is very important. In Europe, we were waiting to see if euro government bonds would be exempt from the Leverage Ratio as well. We think it makes sense in the context that EU governments will need to issue more debt. The problem is the same here as it is in the US: if banks do not have the capacity to take on new EU bond issuance then how will governments raise money? Already there can be inadequate market demand for government issuance, meaning that banks need to keep these assets on their balance sheets. If issuance stays at the same level as today then I do not see a real problem, but if net issuance doubles, what happens then?
SFM: Besides constraints on EU government bond issuance, do you see competitive problems arising as a result of different regulatory regimes?
BB: Yes, especially if EU banks are unable to take on greater government issuance but US banks do not have comparable restrictions. For US banks, the Federal Reserve’s exemptions are a competitive advantage. This is not just an EU issue but also a global problem. I would not say it was right or wrong for the US to exempt Treasuries from the Leverage Ratio, but as a result, other central banks and regulators should consider a response. This is not because it is inherently a good idea, but because the imbalance decreases the competitiveness of their own banks.
SFM: What are your guesses on what the EU repo markets look like six months from now?
BB: We have the Capital Requirements Regulation II (CRR II) coming into force in Q2 2021. This will require European banks to start calculating their Leverage Ratios as a daily average at the end of each quarter. This could change the behavior of some EU banks in the repo markets, but not necessarily all – it depends on the Leverage Ratio position of each institution. Still, every bank will be looking at their balance sheets on a daily basis. We could see less competitive pricing across the board because of the new rules. This would not be unique to Europe, since large EU banks that participate in US and Asian repo markets could also be impacted. The largest players will see the same requirement for the daily Leverage Ratio calculation in all their business units.
SFM: Can you comment on the move by the ECB to temporarily exclude central bank assets from the Leverage Ratio?
BB: By doing that, ECB is getting closer to Fed policy, which is a good thing for EU banks competitiveness. Just one more push for ECB to remove € govies from LR calculation.
Bertrand Bordais is the Global Head of the Market Making Government Bond Repo team at Natixis since 2016. Based in Paris, he reports to Christophe Bensoussan, Global Head of Global Securities Financing (GSF).
Prior to that, Bertrand was a Senior Trader within the MM Government Bond Repo team (2009-2016) and before that he was a Treasurer in the Long Term Treasury Team (2007-2008). Bertrand also worked as a Salesperson in charge of covering the Banques Populaires Network (on both the Treasury activity and Fixed Income Derivatives) from 2000 to 2006. He has been working for the BPCE group since 1996.