The study records growing concern that the cumulative impact of various prudential and market regulations, along with extraordinary monetary policy, could be affecting the ability of the European repo market to function efficiently and effectively. This could, in turn, have wider repercussions for the broader capital markets and so for the real economy.

The ICMA-ERC study, ‘Perspectives from the eye of the storm: the current state and future evolution of the European repo market’, is a qualitative assessment of the current state and future evolution of the European repo market, based on interviews with a wide range of market participants and stakeholders, including bank repo desks, fund managers, inter-dealer brokers, electronic trading platform providers, agency lenders and triparty agents. The highlights are the quotes from traders and participants in the repo business.

The main findings of the ICMA study are:

• Basel III, incorporating Risk Capital Requirements, Leverage Ratio, Liquid Coverage Ratio, and Net Stable Funding Ratio, is the single greatest regulatory driver of change, transforming the structure and dynamics of the repo market. The Leverage Ratio (with the Supplementary Leverage Ratio for larger US banks), is having the most profound impact on the repo market, to the point where repo is becoming unprofitable as a traded product. Repo Trader: “The bottom line is that Basel III has made repo, as a traded product, far less profitable”
• ECB Monetary policy since the 2007-08 crisis has produced excess bank reserves and negative interest rates which dampen repo activity. It has also led to a reduction in the stock of high quality collateral, which is identified as a concern for future fractures in the market, particularly given the widely expected increase in the size and speed of the purchases programme.
• Concern about the effect of planned future regulatory initiatives, in particular the Net Stable Funding Ratio (NSFR), CSDR mandatory buy-ins, and the provision under the Bank Recovery and Resolution Directive (BRRD) for resolution stays. Repo trader: “Once NSFR comes in, then it’s game over. We can all go home.”
• Most banks have already restructured or are restructuring their business models: Key trends include de-risking, deleveraging, transformation from a profit-centre to a cost-centre, reducing head-count, and the merging of repo desks with other funding functions to create centralized liquidity and collateral management hubs. “Many banks now provide repo liquidity to preferred clients as a loss-leader to support other, more profitable businesses and services.”
• Regulators do not fully appreciate how the repo market operates, and that this is apparent in a number of regulatory initiatives, both directly and indirectly related to the repo market. There is concern about the cumulative burden of regulation and the cost of its implementation.
• Stakeholders are trying to adapt and innovate to meet the challenges and looking for potential new opportunities. Most innovations relate to balance sheet optimization, and creating more netting capabilities. Others are being driven by the need for improved liquidity and collateral management. Electronic solutions and improved automation are also being discussed.
• Future 1: there are still many unknowns arising from both regulation and monetary policy making predicting the future evolution of the European market difficult. The consensus views are: an expected reduction in the size of the market; an increase in the diversity of participants; a general widening of bid-ask spreads; and the ongoing merging of banks funding and collateral management functions.
• Future 2: the overriding concern among market participants is that in future, although they expect the repo market to continue in some form, it may be unable to function as effectively and efficiently as it has in the past in providing liquidity and collateral fluidity to the financial system, with potential negative consequences both for markets and the broader global economy.

On the future of the European repo market, the report lists a number of recurring predictions that “paint a releatively vivid picture of what, perhaps, we can reasonably expect:”

• the market will be smaller
• there will be more buy-side participants
• the market will become more sophisticated
• Repos will become a lot more expensive
• liquidity and collateral management functions will continue to merge
• there are two big unknowns: there will be a pause in regulation will restore optimism OR the withdrawal of central bank liquidity will reveal the cracks in the market.

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CTMfile take: This excellent report is essential reading for any corporate who owns repos or is thinking of investing in them. It is quite simply, one of the most effectives reports on regulation and the financial services market we have ‘read’.