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Future of European repo “in jeopardy”
11 March 2013
LTROs continue the decline of the European repo market, but FTT could be an even bigger threat to its future
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The European repo market continued to decline at the end of 2012 as a consequence of the European Central Bank’s Long term Refinancing Operations (LTROs).
The size of the market fell 0.9% to €5.6 on December 12 compared to June 2012, according to the semi-annual survey of the European Repo Council (ERC) of the International Capital Market Association (Icma). The market declined 9.5% since the survey carried out in December 2011.
The survey found a much more pronounced drop of 6.6% since June 2012 when using only the figures for the banks that participated in the past three surveys. The flush of liquidity into the market through the ECB’s LTROs has led to banks decreasing their reliance on funding from repo.
The size of the market is still well above the dip in December 2008 but ERC chairman Godfried De Vidts said despite the continued robustness of the European repo market, its future "is in jeopardy”. He pointed out that the Basel Committee’s work on pushing interbank lending transactions to a secured basis could be in vain in light of new proposals to tax repo transactions.
“The European Commission’s latest proposal for Financial Transactions Tax (FTT) comes at a time when the Basel Committee has guided interbank lending transactions away from an unsecured to a secured basis and when wholesale market participants, together with the Central Bank community, have moved to the repo market because it is the safest way of distributing liquidity throughout the European banking system. The FTT proposals to tax repo transactions put the economic viability of repo, including tri-party, transactions at significant risk, which will lead to less liquidity provision to the real economy.”
De Vidts also said the much-hyped collateral crunch could become reality if the proposed tax goes ahead. There are concerns that the higher demands for collateralised transactions and central clearing of OTC derivatives could cause a shortage of collateral. De Vidts predicted that the extra demand for collateral will exceed the additional supply of collateral in the period between 2013 and 2014.
“If the FTT on repo transactions (which facilitate collateral being available where it is needed) goes ahead, the regulatory collateral crunch will actually materialise. Is that what we really want to happen?”
The impact of the FTT on securities lending and repo was discussed recently at a conference in Hong Kong where a regulatory expert said the tax will “probably apply to the posting and return of collateral”.
The survey also found that there was a greater availability of core European government bonds as investors stopped hoarding safe haven assets such as German sovereign bonds following the uptick in market sentiment in the final quarter of 2012.