Australia
15 May 2018
Moving into a new phase of growth, it is very clear that the Australian repo market is very much on the march
Image: Shutterstock
The Australian repo market is moving into a new phase of growth. This is one of the striking remarks to emerge from conversation with experienced market participants on the subject of how the local market compares with other developed markets.
Australian repo might be slightly behind the times, local practitioners concede, but it is in catch-up mode, and this catch-up could happen relatively quickly.
Hugh Leonard, director of repo sales at ANZ in Sydney, sees the current phase as a growth story linked to the increased issuance of government bonds in the wake of the global financial crisis. The synchronised adoption of lower official interest rates in most of the world has also contributed to the growth.
Issuance across Australian Government Securities (AGS), the bedrock of the repo market, has seen a significant increase from just AUD $60 billion in March 2008 to over AUD $525 billion as of late.
Austraclear, the local central securities depository, has approximately AUD $2 trillion fixed income issuance on its books. This represents a near doubling in a decade.
Australia’s attractions
The increased issuance and associated improved liquidity has attracted a growing range of domestic and offshore institutional involvement to the local bond market. The roster of investors now features domestic and offshore banks, sovereign wealth funds, central banks, hedge funds and other asset managers. For domestic investors subject to domestic risk and liquidity rules, Australian government debt is the risk-free paper of choice. Offshore investors are attracted by the combination of the AAA rating of AGS, the traditional yield pick-ups on offer, political stability, broader economic maturity and liquidity.
Each of the above will have differing funding requirements. Hedge funds generally seek to fund their holdings via repo, whereas sovereign wealth funds may simply buy and hold, meaning they have less of a funding requirement or even none at all.
One repo trader describes Australia as a fairly liquid repo market onshore in government and semi-government bonds with liquidity up to three months on the street.
The major cash provider is the Reserve Bank of Australia (RBA), which has daily open market operations (OMO) and uses mainly reverse repo of RBA eligible securities as the product of choice to keep appropriate liquidity in the Australian banking system, he notes.
According to the RBA, the gross size of the Australian dollar repo market was calculated to be worth AUD $193 billion in December 2017, approximately three times larger than its 2009 size.
However, this additional funding demand is occurring at a time when banks have less capacity to offer funding due to balance sheet limitations driven by liquidity and capital regulation.
Anecdotally, the Australian repo market has historically been plain vanilla (bilateral settlement of delivery versus payment repo) and has displayed limited diversification of client participation or structured transactions.
Change is afoot
But change is afoot. As with global markets, the domestic market is responding to the changing regulatory and operational environment. Transactions are moving away from a predominance of short-term overnight funding, towards incorporating more structured trades and credit financing.
And, as already alluded to, investors in Australia and elsewhere are showing more of an interest. Pre-global financial crisis, the RBA via OMO provided approximately 50 percent of cash to the repo market.
This has fallen to just 25 percent on the back of today’s broader range of market participants and the increase in market size, driven mainly by increased issuance of AGS.
The market is lop-sided, however, with demand for cash exceeding supply, leading to volatile and relatively high repo rates.
Leonard observes: “One unique characteristic of the Australian repo market is that the price of secured repo-related borrowing is higher than that of unsecured borrowing.”
The notable spike higher in repo rates witnessed since early 2018 is in part owing to this structural imbalance.
Three-month repo funding levels at the RBA OMO had been averaging overnight index swaps (OIS) of plus 10/15 basis points spread in 2016 and OIS plus 20/25 basis points spread in last year. However, the average thus far in 2018 is OIS plus 30/35, with levels printing as high as OIS plus 90 for 32 days seen over March quarter end.
Tri-party on the move
The development of tri-party repo is delivering a range of additional options to the market and market participants, says one commentator.
Tri-party is giving the collateral-giver flexibility on the bonds they post to collateralise repo transactions, securities lending transactions and open market operations all over the world.
One market participant notes that as long as the collateral-giver has enough securities, that are eligible for the pre-agreed tri-party set, they have the flexibility to post any of these at any given time to the cash giver, keeping the flexibility to switch between eligible collaterals without the need to close existing trades and re-open new ones.
The market participant adds: “It’s the tri-party agent that takes care of the substitutions of eligible bonds at any time.”
“A good example of this is the ability in Australia to submit to the RBA collateral for open market operations via ASX Collateral, the domestic tri-party agent, making it possible for banks to switch the bonds they submit for their OMO allocations.”
Leonard also suggests: “Tri-party repo requires less administration and high volume trading, making it an easier way to transact in the repo market.”
ASX Collateral, which went live in June 2014, has seen strong growth.
Tri-party repo balances reached a record high in March 2018, representing approximately 13 percent of the domestic market settled via tri-party, with a high of 43 percent of RBA OMO settling via ASX Collateral.
It is clear from this body of evidence that the Australian repo market is very much on the march.
Figure 1: Growth in AGS and percentage held by non-residents
Australian repo might be slightly behind the times, local practitioners concede, but it is in catch-up mode, and this catch-up could happen relatively quickly.
Hugh Leonard, director of repo sales at ANZ in Sydney, sees the current phase as a growth story linked to the increased issuance of government bonds in the wake of the global financial crisis. The synchronised adoption of lower official interest rates in most of the world has also contributed to the growth.
Issuance across Australian Government Securities (AGS), the bedrock of the repo market, has seen a significant increase from just AUD $60 billion in March 2008 to over AUD $525 billion as of late.
Austraclear, the local central securities depository, has approximately AUD $2 trillion fixed income issuance on its books. This represents a near doubling in a decade.
Australia’s attractions
The increased issuance and associated improved liquidity has attracted a growing range of domestic and offshore institutional involvement to the local bond market. The roster of investors now features domestic and offshore banks, sovereign wealth funds, central banks, hedge funds and other asset managers. For domestic investors subject to domestic risk and liquidity rules, Australian government debt is the risk-free paper of choice. Offshore investors are attracted by the combination of the AAA rating of AGS, the traditional yield pick-ups on offer, political stability, broader economic maturity and liquidity.
Each of the above will have differing funding requirements. Hedge funds generally seek to fund their holdings via repo, whereas sovereign wealth funds may simply buy and hold, meaning they have less of a funding requirement or even none at all.
One repo trader describes Australia as a fairly liquid repo market onshore in government and semi-government bonds with liquidity up to three months on the street.
The major cash provider is the Reserve Bank of Australia (RBA), which has daily open market operations (OMO) and uses mainly reverse repo of RBA eligible securities as the product of choice to keep appropriate liquidity in the Australian banking system, he notes.
According to the RBA, the gross size of the Australian dollar repo market was calculated to be worth AUD $193 billion in December 2017, approximately three times larger than its 2009 size.
However, this additional funding demand is occurring at a time when banks have less capacity to offer funding due to balance sheet limitations driven by liquidity and capital regulation.
Anecdotally, the Australian repo market has historically been plain vanilla (bilateral settlement of delivery versus payment repo) and has displayed limited diversification of client participation or structured transactions.
Change is afoot
But change is afoot. As with global markets, the domestic market is responding to the changing regulatory and operational environment. Transactions are moving away from a predominance of short-term overnight funding, towards incorporating more structured trades and credit financing.
And, as already alluded to, investors in Australia and elsewhere are showing more of an interest. Pre-global financial crisis, the RBA via OMO provided approximately 50 percent of cash to the repo market.
This has fallen to just 25 percent on the back of today’s broader range of market participants and the increase in market size, driven mainly by increased issuance of AGS.
The market is lop-sided, however, with demand for cash exceeding supply, leading to volatile and relatively high repo rates.
Leonard observes: “One unique characteristic of the Australian repo market is that the price of secured repo-related borrowing is higher than that of unsecured borrowing.”
The notable spike higher in repo rates witnessed since early 2018 is in part owing to this structural imbalance.
Three-month repo funding levels at the RBA OMO had been averaging overnight index swaps (OIS) of plus 10/15 basis points spread in 2016 and OIS plus 20/25 basis points spread in last year. However, the average thus far in 2018 is OIS plus 30/35, with levels printing as high as OIS plus 90 for 32 days seen over March quarter end.
Tri-party on the move
The development of tri-party repo is delivering a range of additional options to the market and market participants, says one commentator.
Tri-party is giving the collateral-giver flexibility on the bonds they post to collateralise repo transactions, securities lending transactions and open market operations all over the world.
One market participant notes that as long as the collateral-giver has enough securities, that are eligible for the pre-agreed tri-party set, they have the flexibility to post any of these at any given time to the cash giver, keeping the flexibility to switch between eligible collaterals without the need to close existing trades and re-open new ones.
The market participant adds: “It’s the tri-party agent that takes care of the substitutions of eligible bonds at any time.”
“A good example of this is the ability in Australia to submit to the RBA collateral for open market operations via ASX Collateral, the domestic tri-party agent, making it possible for banks to switch the bonds they submit for their OMO allocations.”
Leonard also suggests: “Tri-party repo requires less administration and high volume trading, making it an easier way to transact in the repo market.”
ASX Collateral, which went live in June 2014, has seen strong growth.
Tri-party repo balances reached a record high in March 2018, representing approximately 13 percent of the domestic market settled via tri-party, with a high of 43 percent of RBA OMO settling via ASX Collateral.
It is clear from this body of evidence that the Australian repo market is very much on the march.
Figure 1: Growth in AGS and percentage held by non-residents
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