Unprecedented volatility and dislocation across
Europe’s repo market could become a common
occurrence, experts at the ICMA claim.
The crucial short-term loan market, used by banks and
investors, "effectively broke down" last year, Richard Comotto,
a senior visiting fellow at the capital markets trade body,
said on Tuesday.
"That’s something that did not happen either
during the Lehman crisis or over the sovereign bond crisis," he
added in his 'post-mortem' study of the market.
"There is a very real concern that the market behavior over
the 2016 year-end will not be a one-off event."
Repos, or repurchase agreements, are critical sources of
funding for many institutions. Dealer banks sell securities
with a promise to repurchase at a later date.
Often activity is reduced around the calendar year-end,
meaning markets tend to be thin and more volatile.
However, conditions at the end of 2016 were extreme.
Capital requirements and leverage ratios have reduced repo
market activity, and thereby the supply of
Meanwhile asset-purchases by the ECB have escalated stress
across the market and increased the premium paid for High
Quality Liquid Assets (HQLA).
"The shortage [of collateral] has not been much relieved by
the Eurosystem’s securities lending arrangements,"
according to Comotto.
Some buy-side firms were able to leverage bank relationships
and negotiate some last-minute repo liquidity, albeit at a
Others, unable to access the repo market, could only resort
to buying short-term assets at distorted levels.
One asset manager told Comotto it was like "watching a train
smash in slow motion; you could see it happening, but could do
nothing about it."
Defining long-term behavior
At this stage, ICMA's Comotto says it is difficult to divine
how the change in the composition of the repo market will
affect its long-term behavior.
"One the one hand many market-users, particularly
traditional liquidity providers, have been structurally
deleveraging in response to their own increased risk aversion
and regulatory pressure to reduce leverage and increase
"On the other, there is evidence of a migration into the
repo market by banks and non-banks who have traditionally
relied on unsecured money markets."
Speaking at the Deutsche Borse GFF summit in Luxembourg last
month, Yves Mersch, member of the ECB’s
executive board, said there is "no doubt" that European
repo markets today are operating in "unprecedented
"Banks and other market participants report a decrease in
market making activities and collateral scarcity in
repo-markets," he added. "The perception of a challenging
environment can therefore not be denied."
However, Mersch said that market stress should fade with
the continued economic recovery and players will
adjust their business models over time amid a new regulatory