Europe's repo market at risk of meltdown

Author: Danielle Myles | Published: 20 Nov 2015
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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 irreparably damaged.

The ICMA study paints a detailed picture of how the vital yet largely misunderstood element of wholesale banking is evolving in response to regulatory initiatives as well as ECB monetary policy.

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 functioning

The 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 economy.

"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 Vidts

"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 lending;
  • 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 market;
  • 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 liquidity.

"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 market’s issues.

ICMAFirst, 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," said Hill.

"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 sustainable.

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 cope.

"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 to transaction.

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.

See also

What is the prognosis for the repo market?
Regulators still don’t understand repo
EU repo rules must entice buyside
Six repo myths debunked