Repo outstandings are down, according to the International Capital Market Association (ICMA) which has just published two separate studies on the continuing cumulative effect of regulation on the ability of financial markets to support economic growth.
The 28th ICMA European Repo Council European repo market survey. ICMA says this survey of the amount of repo business outstanding on December 10 2014 sets the baseline figure for market size at EUR 5,500 billion, (EUR 5.5 trillion) representing a decline from the figure of EUR 5,782 billion recorded in the last survey in June 2014. It estimates that the market has shrunk by at least 4.8 percent since June and by 2.8 percent since December 2013.
Survey participants indicate that the continuing reduction in repo activity reflects depressed business and that new leverage and liquidity regulations aimed at reducing the reliance of banks on wholesale short term funding are beginning to bite. Market participants cite the Leverage Ratio as a major constraint on balance sheets and addition to the cost of business.
The impact of regulation appears to be greatest on commoditized, short-term, interdealer repos of government bonds, where margins are thinnest and where banks are least able to recover transactions costs (including increased regulatory capital).
The average maturity of business lengthened, reflecting in part seasonal longer-term financing to bridge the end of the year but possibly regulatory pressure to seek more stable (ie longer-term) liabilities.
The second of the two papers, the ICMA Impact Study for CSDR Mandatory Buy-ins study, highlights a further major challenge to capital market activity (including repo) posed by the mandatory buy-in provision of the Central Securities Depository Regulation (CSDR).
A buy-in may occur in the case of a failure to deliver the securities that were agreed on a trade between two counterparties, the disappointed buyer has the right to appoint an agent to purchase the securities at market price for guaranteed delivery at the price originally agreed and to charge the seller the difference. Buy-ins under the current discretionary regime in fixed-income markets are infrequent. The move to a regime where buy-ins are actively enforced introduces additional difficulties and cost into doing business.
If mandatory buy-in regulation, scheduled for early 2016, is implemented liquidity across secondary European bond and financing markets will reduce significantly, while bid-offer spreads will widen dramatically, says ICMA.
The European repo market will also be radically re-shaped, driving more reliance on very short-dated repo funding (‘exempt’ repo).
The more stable, fixed-term markets will see dramatic widening of spreads for more liquid securities, and a total withdrawal of liquidity for less liquid securities, including some sovereign and public bonds, and most corporate bonds.
