The International Capital Markets Association’s European Repo and Collateral Council (ERCC) has published a briefing note on the performance of the European repo market at year-end 2021.
Traditionally published by the ERCC in January, the report reflects on how end-of-year conditions have impacted EUR, GBP, USD and JPY repo markets, drawing on market data and accounts supplied by buy-side and sell-side market participants.
The report concludes that, in the eyes of market participants, the year end for the euro repo market was orderly from an operational standpoint, particularly for core sovereign collateral. Alongside significant pre-positioning of collateral, central bank lending programmes played an important role in delivering this stability.
Notwithstanding, the 2021 year end was the most expensive for core repo since 2016 and for the longest period leading up to any recent year end.
By November, year-end GC was being priced expensively, with implied rates for German GC, for example, sitting at between -4.5 and 5.0 per cent. Implied rates continued to tighten through November, reaching a low of around -9 per cent before easing by mid-December.
Non-core repo rates were even tighter than 2016, leading to the most expensive year-end turn since the introduction of the euro.
The report says that it was the periphery segment that particularly caught the market off guard. Liquidity began to dry up as the year end approached, but few anticipated a tightening of more than 100bps to previously implied rates.
However, Italian general collateral (GC) averaged -3.37 per cent in the interbank market, with specifics averaging -4.19 per cent down to a low of -4.86 per cent. Spanish GC averaged 3.41 per cent and specifics -5.02 per cent, with some specials trading as tight as -10 per cent bilaterally.
This sudden tightening of periphery rates was attributed particularly to collateral scarcity, potentially as a result of bonds being used in the European Central Bank’s (ECB’s) Targeted Longer-term Refinancing Operations and weak access to underlying central bank lending programmes, either directly or via intermediaries.
Several market participants voiced their concern about the “extreme trading levels” observed in the euro repo market over year end, the relative absence of liquidity and the fact that some market participants were pre-positioning, at significant cost, from October onwards. Given these conditions, they questioned whether this is consistent with a functional, healthy repo market.
Buy-side respondents indicated that although some dealer counterparties did elect to close their books in the run up to the year end, it was still generally possible to trade, even in size, although it was often expensive to do so.
Some market participants reported a significant rise in settlement fail rates across the year end. For some, this was a sign of market stress or dysfunction. For other respondents, this was not atypical when compared with previous years.
On this point, some questioned how well the market would have fared had not so much pre-positioning been done in advance. Survey participants observed that the market began positioning for year end through the term market from October, with much of the necessary trading activity already done by mid-December. During Q4 21, Eurex recorded an 83 per cent YoY increase in term repo trades with end-legs settling in January 2022.
The report concludes that sterling repo rates experienced downward pressure over year end owing to excess reserves and a short supply of specials. Participants report that liquidity was weak in the approach to the turn, but the market remained relatively orderly with Delivery-by-Value trading around -0.60 per cent and sub-10 year specifics trading at 10-25bps tighter.
Term rates remained steady over year end, although participants indicate that term GC spreads since Q2 2021 have been the tightest in memory relative to SONIA (at 7-12bps) — largely as a result of excess reserves.
USD repo rates remained broadly unaffected by the turn in both onshore and offshore funding markets, according to the report, with participants observing strong liquidity for both GC and specials. The Federal Reserve’s Overnight Reverse Repo facility provided an important pressure valve that helped to ease downward pressure on rates in the run-up to year end.
The ICMA ERCC briefing note on the European repo market at year end has been published each January since 2017. It draws heavily on data supplied by Eurex, Bloomberg and CME Group Benchmark Administration.
Commentary and insights from AXA IM, Bank of America Merrill Lynch, Barclays, BlackRock, Eurex, HVB Unicredit, JP Morgan, LCH and UBS were key in preparing the report.
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