European repo market suffers fall

European repo market suffers fall

The European repo market shrunk by at least 8.2% between June and December 2013 as regulation casts an uncertain shadow over the future of this industry.

New figures from the International Capital Market Association’s European Repo Council (ERC) revealed the market suffered a “sharp decline” in that period from €6.08bn ($8.3bn) to €5.5bn.

The contraction could be down to several factors, such as the shrinkage of repo books at the end of the year and the liquidity provided by the ECB in December to relieve seasonal shortages in funding.

The drop could also have been driven by expectation of future regulation impacting this market, admits Richard Comotto of the Icma Centre, University of Reading.

However the fall was far below the lowest figure recorded for the repo market in December 2008.

“The repo market still faces an unclear landscape. The impact of regulatory reforms and interactions with the central bank community continue to increase uncertainty. Market users need to be alert to changing market forces, including the increased use of collateral while the introduction of mandatory clearing for OTC derivatives is taking place,” said Godfried De Vidts, chairman of the ERC.

The future of the repo market in Europe is uncertain in the light of future regulations such as the proposed financial transactions tax (FTT) in 13 EU member states.

There is also concern that the Basel III liquidity coverage ratio could force banks to sell their low-margin government bonds if it becomes too capital intensive to use them in repo transactions. This would have a knock-on effect on the government bond market.

The Basel Committee’s recently proposed bilateral netting in the leverage ratio could remove some of the capital pressures on banks involved in repo, but there is still uncertainty over the degree of variance across jurisdictions as the rules are finalised by national regulators.

The US repo market is also feeling the heat as a result of regulators' focus on fire sale risk, in addition to fears over the impact of the end of quantitative easing.

One example of a repo transaction is where a bank lends cash to an investor in return for collateral which is usually government bonds such as US treasuries. The bank could then enter into a reverse repo transaction with a cash lender such a money market fund, offering the bonds as collateral in return for cash.

Most Popular