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European repo market suffers fall
23 January 2014
Uncertainty over future regulation weighs down the market
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.
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