The leverage ratio and incoming net stable funding ration
(NSFR) could be the deathknell of Europe’s repo
market, according to respondents to an
International Capital Markets Association (ICMA) survey
released on Wednesday.
The European Central Bank’s (ECB) bond-buying
programme is helping to mask the severity of the
market’s problems. But unless regulations that
penalise short-term lending are changed, European repo could be
The ICMA study paints a detailed picture of how the vital
largely misunderstood element of wholesale banking is
evolving in response to regulatory initiatives as well as ECB
Godfried de Vidts, chair of the European Repo Council hopes
the report highlights that European repo can still be salvaged.
"But some bankers say it’s already too late
– this market is on its knees," he said.
There is a very well
expressed fear that the market could just stop
Capital Markets Union’s (CMU) call for
evidence on the cumulative impact of regulation could
provide an opportunity for feedback on this point. Repo has
been battered by a long list of reforms that penalise
short-term lending, which in turn feeds through to the real
"The CMU is not about redoing everything, but if you give
concrete examples of what does and doesn’t work,
that something is wrong, they will look at it," said de
"It’s important that we are on red alert. And
if nothing is done by the CMU framework, we are most likely
going to see more of a meltdown of this market, and there will
be damage for the final retail investors," he added.
- An ICMA survey has revealed that European
repo's ability to provide efficiently provide
liquidity within wholesale banking is
being jeopardised by the cumulative impact of
post-crisis reforms that penalise short-term
- Some bankers say the market is beyond being
salvaged, while others say the market won't be able to
perform in a stress scenario;
- QE and the transformation of repo desks from
profit centres to cost centres is masking the dire state of
- The CMU's call to action could provide an
opportunity to reverse some of the damage.d
Hiding a multitude of sins
The overall message from the 55-page report is that that the
market appears to be limping on, according to ICMA director
Andy Hill. But the data is not telling the whole story, and
existing and future reforms threaten its efficiency and
"The concern is that the market will have to change
radically, that liquidity will reduce sharply, pricing will
have to adjust. And there’s a broad concern that
the market will not be able to perform its functions
efficiently and effectively, particularly in a stress
scenario," Hill said.
While volumes are relatively stable and pricing
hasn’t changed radically, this does not reflect
the increased cost of capital required to trade repo. The
report reveals a number of factors masking the
First, Basel III – which
is repo’s major regulatory headache – is
not yet being uniformly applied. While US and some European
banks have reduced their activities on account of the capital
charges, those that don’t yet have to comply have
picked up the slack.
The leverage ratio has been the major driver, but it could
be outdone by incoming Basel measures. "NSFR is yet to come,
which some believe could be the deathknell of the repo market,"
"Some banks think NSFR could be worse than the leverage
ratio, in that it could make repo so unprofitable that it
isn’t worth trading anymore," he said. However, he
noted that other respondents were less pessimistic because NSFR
could be absorbed at the bank level – across all
businesses – not at the trading desk level."
Second, repo desks are being restructured to de-risk,
deleverage and reduce headcount, as well as being transformed
from profit centres to cost centres.
"What a lot are doing is providing liquidity and competitive
pricing but as a loss leader…it is being subsidised by
other businesses," said Hill. But interviews with buyside and
sellside revealed that those losses weren’t
Third, the ECB’s quantitative easing is helping
to soften the regulatory blow by becoming the lender and
borrower of first resort. Some survey respondents describe it
as 'hiding a multitude of sins’, and once monetary
policy normalises, it’s possible that repo desks
will have been pared back so much that they can’t
"There is a very well expressed fear that the market could
just stop functioning," said Hill.
The future market
While it’s possible for repo participants to
plan around reforms taken in isolation, the long list of rules
hitting the market makes it impossible to respond.
In addition to NSFR and the leverage ratio, there is the
liquidity coverage ratio, Bank Resolution and Recovery
Directive, Dodd-Frank, European Market Infrastructure
Regulation, Markets in Financial Infrastructure Directive,
Central Securities Depository Regulation, Securities Financing
Transaction Regulation, plus more.
Some bankers say
it’s already too late – this
market is on its knees
"The risk now clearly shown is that policymakers at large
didn’t have a helicopter view," said de Vidts. "No
one really took a view of what the cumulative impact is."
When asked to describe what the market in two to three
years’ time, survey respondents said it would be a
lot smaller, more buyside participants, and much more difficult
The matchbook model of providing market liquidity is
breaking down and transactions will be much less standardised,
more bespoke and highly negotiated.
The report is based on interviews with more than 60
individuals from 47 entities spanning bank repo desks, buyside,
interdealer brokers, and central counterparties. Research was
conducted from June to October 2015.
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