New rules need new tools
When the rules and incentives governing market behaviour are rewritten, the sensible course of action is to look for new tactics to help you achieve your strategic goals.
Banks have come to rely on the repo markets as a key plank of their short-term funding strategies – especially, but not exclusively, to provide liquidity in the fixed income and derivatives markets – but incoming capital rules are hiking costs. In particular, Basel III’s efforts to constrain banks’ balance sheet muscle are curtailing repo market activity.
The biannual survey of the International Capital Market Association’s European Repo Council (ERC) reported outstanding repo business down 2.9% in June 2015. Many feel this is the tip of the iceberg.
Days before however, repo market participants gathered at the London Stock Exchange to discuss these challenges, as well as the current and future progress of one of the potential solutions.
Rather than terminal decline, the debate suggested repo faces a period of sometimes painful changes, before reaching maturity and stability. In short, repo is evolving from a largely bilateral market, with many aspects of transactions negotiated case-by-case, to a more standardised, scalable and transparent framework, characterised by central clearing and tri-party collateral management, driven only in part by regulators.
Sell-side repo market participants hope that their need to make more cost-effective and nimble use of collateral in this new capital-constrained era can be met through innovation.
New ways of working
While the markets’ changing needs cannot be addressed by a single solution, €GCPlus provides a clear example of how collaboration between services providers can play a major role in the market’s response. €GCPlus combines LCH.Clearnet’s central clearing and risk management capabilities with Euroclear’s collateral management system and tri-party repo network, refinancing and liquidity provision from the Banque de France and transparency through electronic platforms BrokerTec and MTS.
Trades that are backed by standardised baskets of high-quality collateral and cleared at a Central Counterparty (CCP) can be netted, thereby bringing down required regulatory capital. But the service can also appeal to a wider range of counterparties, including corporate treasury departments that are increasingly interested in secured lending opportunities as an alternative to traditional cash investments.
According to Michel Albertini, European head of repo trading at BNP Paribas, centrally cleared repo transactions backed by general collateral baskets hold both operational and regulatory benefits for banks’ repo desks and treasury departments. “As effectively an intermediation business, the repo desk is an intensive-balance sheet user. And as a market maker, a key driver for our use of CCP-cleared repo is the netting capacity it provides in these balance-sheet sensitive times,” he said.
From an operational perspective, Albertini welcomed innovations that deliver flexibility. “Operationally speaking, it is important for me to have flexibility when optimizing my inventory as a liquid basket that can be traded late in the day. Some modifications are still required given the constraints of LCR and NSFR, but we are moving in the right direction.”
Albertini is impatient for wider adoption, even beyond the repo desk. “We want non-banks participating, perhaps at first as cash givers only, but ultimately accessing cleared repo through clearing agents as both cash givers and takers.”
Repo traders have been forced to focus on liquidity by post-crisis reforms, suggested Greg Markouizos, head of fixed income finance at Citi, asserting the urgent need for products that support efficient liquidity management to manage current and contingent risks inherent in banks’ business models. “This service allows collateral at Euroclear to be mobilised without an additional step and allows for the connection between Central Bank and Commercial Bank money that is critical in today’s liquidity management environment,” he added.
Bank treasuries too are finding the maturing repo market an attractive proposition. For Dominique Le Masson, head of central treasury at BNP Paribas, a key priority is to manage the banks’ liquidity buffer of high-quality liquid assets in line with the Basel Liquidity Coverage Ratio (LCR).
Beating the benchmark
“Banks must borrow term cash to be LCR-compliant,” she said. “As such we are long in cash, but need to be able to reinvest it. We could deposit it direct with the Banque de France, but need a better yield to beat our benchmark. We use reverse repo to optimise liquidity management and have turned to €GC+ because of the availability of cash, interoperability between Euroclear France and Euroclear Bank, and ease of use in terms of access to central-bank eligible securities. Looking ahead, once T2S allows easier collateral movement across euro-zone borders, use of €GC+ will make circulation of cash against securities even easier.”
Momentum is building behind efforts to reform and improve the repo market, but there is room for further innovation and growth. Nevertheless, rumours of the demise of repo appear to have been greatly exaggerated.