Against a turbulent backdrop and as we head into Finadium’s Rates & Repo Europe conference next week, we check in with our panelist experts on the liquidity environment and some of the ways that’s translating into market dynamics.
Repo market liquidity conditions are being determined by factors such as interest rate rises, central bank activity and regulatory constraints, said Andy Turvey, director of Sales for Europe, Middle East and Africa (EMEA) at electronic trading platform GLMX, who will be moderating a panel on “Liquidity Conditions in the UK and Eurozone“, joining colleagues from J.P. Morgan, Natixis, HSBC, BlackRock and Citi.
The definition of liquidity is itself a bit of a moveable feast, and Turvey describes it as “the ability to get the business done”. When markets freeze up, whether as a result of credit constraints, or macroeconomic or geopolitical events, there have been times when it gets difficult to do that in repo markets. “Any market that allows you to execute trading strategies without paying an excessive cost for doing that, is a liquid market,” he explained.
Turvey’s background goes back to voice broking in an open outcry trading environment before he joined J.P. Morgan for 18 years, running the client side of the repo business. Today’s repo market has reached an inflection point for the digitization of securities financing activity, he said, with GLMX volumes growing exponentially over the last couple of years.
In European markets, the scale and pace of interest rate rises continue to be closely watched. He noted that between July 2010 and July 2021, there were 13 rate hikes at 25bps across three major central banks – European Central Bank, Bank of England, and the Federal Reserve. Contrast that to 2022, during which there was the equivalent of 40 rate hikes of 25bps at those same institutions in the one year alone. This, he added, created significantly more volatility in financing markets.
“Towards the end of the last year, there was a lot of scarcity in the repo market, a lot of bonds trading very rich, a lot of anxiety around year-end and the capacity that was out there. Thus far in 2023, the environment seems more stable and benign,” he said. “The repo market has always been cyclical by its nature: periods of stability and benign financing conditions tend to get followed by periods of volatility (and) disruption, which tend to create opportunities for both buy- and sell-side participants.”
The kinds of signals Turvey expects to see along this vein are widening spreads, increased demand for capacity, and more bonds trading special: “Repo market professionals, frustrated by years of low rates, will be potentially in a position to do what they are best at, generate revenue.”
He added that the hedge fund community has come back “with a vengeance” looking to add risk and to source the capacity to facilitate it. Meanwhile, across the various market participants, the liquidity environment’s new phase is raising questions on what kind of tools and technologies are coming to the fore.
Managing growth and crisis
The surge in electronic trading and technology-based services in securities financing provides a new means for the buy-side to access one large and stable cleared liquidity pool, which is particularly important when the repo market experiences strains from crises, said Emmanuel Rolland, chief operating officer for RepoClear and Collateral and Liquidity Management at LCH SA, the Paris-based clearing operation handling euro-denominated government debt repo, GC repo and cash transactions.
Before joining LCH, Rolland worked for more than 10 years on the buy-side with AXA Investment Managers in roles that included focuses on OTC derivatives management, multi asset client solutions, and trading and securities financing. He will be sharing his expertise on the “Client Clearing in 2023” panel.
The euro repo market has been growing between 8-10% on average per year over the last years, reaching some €10.4 trillion ($11.1tn) as of December 2022, according to the latest ICMA European repo survey. The dealer-to-dealer side of the market is mostly cleared repo, while the dealer-to-client side remains largely bilateral, explained Rolland, the latter of which results in a fragmented liquidity pool.
“Intermediation is going to be a key problem of the EU Bonds market. We see more and more issuance to cope with macroeconomic challenges, but this issuance is flowing towards the same subset of banks,” he said. “We have a problem of ever-growing supply versus a fixed amount of demand and ability to intermediate.”
Cleared repo provides solutions thanks to the netting of positions against the CCP, which in turn increases banks’ ability to intermediate, he added. The buy-side is becoming more conscious of liquidity squeezes at quarter and year-ends as banks clean up balance sheets, and LCH RepoClear is seeing growing demand coming from pension funds, insurance companies and hedge funds.
“Different governments throughout the last decade have increased debt issuance by very large numbers through different crises and monetary policies,” said Rolland. “This has led to increased fragmentation in the bilateral market for the buy-side. By using the cleared repo market, banks’ resource management pressures can be reduced while the buy-side has greater and more reliable access to liquidity in both times of market stress and calmer waters.”
GLMX’s Turvey noted that repo market participants do still tend to operate in a siloed way, and Finadium’s Rates and Repo Europe provides an opportunity for a broader view: “These sectors of the market are all like a mosaic that fits together and the more familiar we are with those individual pieces of the mosaic the more informed we are going to be about trends, potential headwinds, and opportunities.”
Finadium’s first annual Rates & Repo Europe will be held at the London Stock Exchange Group on 29 March 2023. This live event is for cash investors, dealers, market intermediaries, technology firms and other service providers to understand the dynamics behind changing markets and the regulatory and technology environments. You can register here.