HQLA stuck in the pipes, says European Central Bank
24 April 2017 Frankfurt
Image: Shutterstock
EU collateral liquidity has “deteriorated” due to government bonds being ensnared in stringent collateral reuse and new margin rules, the European Central Bank (ECB) has found.
All types of euro-denominated collateral has suffered from the effects of EU liquidity regulations requiring banks to retain more high-quality liquid collateral on their books, but the central bank noted that “the deterioration was most pronounced for government bonds”.
The market’s troubles were revealed as part of the ECB’s quarterly qualitative survey on credit terms and conditions in euro-denominated securities financing and over-the-counter (OTC) derivatives markets.
The survey collected qualitative information on changes between December 2016 and February 2017. The results are based on responses from a panel of 28 large banks, comprising 14 euro area banks and 14 banks with head offices outside the euro area.
Credit terms offered to counterparties, both in the provision of finance collateralised by euro-denominated securities and in OTC derivatives markets, tightened for all counterparty types, according to survey respondents.
In its April report on the survey results, the ECB said: “By and large, the tightening of non-price terms was as important as the tightening of price terms.”
“Worsened market liquidity and functioning, the reduced availability of balance sheet or capital and increasing internal treasury charges for funding were the most frequently cited reasons why overall credit terms had become less favourable, in addition to the tightening of non-price credit terms due to the implementation of new regulatory requirements on margins for non-cleared OTC derivatives.”
“Credit terms are expected to tighten further for all types of counterparty over the next three-month reference period, between March and May 2017.”
The report continued: “Looking at patterns in credit terms over a longer horizon, compared with one year ago responses indicated less favourable overall credit terms for all types of counterparty except banks and dealers.”
“The tightening of credit terms was more pronounced with respect to non-price terms than for price terms. Also, overall credit terms for secured funding tightened year-on-year when government bonds, high-yield corporate bonds or equities were used as collateral.”
Securities finance market participants have previously pointed to the slew of new regulatory requirements for higher liquidity for bank and non-bank balance sheets as an acute stress point behind the overall market liquidity deterioration.
The ECB’s own asset purchase programme has also been criticised for only supporting a limited securities lending programme to release these securities back into circulation.
The central bank has cut its monthly purchase target from €80 billion worth of government bonds to €60 billion, as of 1 April.
It also loosened its rules on eurosystem central banks’ ability to accept cash collateral in their public sector purchase programme’s (PSPP) securities lending facilities, without having to reinvest it in a ‘cash-neutral manner’.
The International Capital Market Association’s (ICMA) second quarterly report on market practice and regulation for 2017 noted: “In the weeks leading up to [the March] quarter-end, the market had shown a high degree of uncertainty and nervousness, with repo rates being priced very wide (and with general collateral trading below -3 percent)”.
Although general collateral and special rates were tighter than what is normally considered comfortable, it was “nothing as dramatic as seen over the 2016 year-end,” ICMA added.
“This should not be surprising, given the extreme levels seen at the end of December, and the relatively asymmetrical risks related to anticipating demand and supply imbalances over statement dates.”
All types of euro-denominated collateral has suffered from the effects of EU liquidity regulations requiring banks to retain more high-quality liquid collateral on their books, but the central bank noted that “the deterioration was most pronounced for government bonds”.
The market’s troubles were revealed as part of the ECB’s quarterly qualitative survey on credit terms and conditions in euro-denominated securities financing and over-the-counter (OTC) derivatives markets.
The survey collected qualitative information on changes between December 2016 and February 2017. The results are based on responses from a panel of 28 large banks, comprising 14 euro area banks and 14 banks with head offices outside the euro area.
Credit terms offered to counterparties, both in the provision of finance collateralised by euro-denominated securities and in OTC derivatives markets, tightened for all counterparty types, according to survey respondents.
In its April report on the survey results, the ECB said: “By and large, the tightening of non-price terms was as important as the tightening of price terms.”
“Worsened market liquidity and functioning, the reduced availability of balance sheet or capital and increasing internal treasury charges for funding were the most frequently cited reasons why overall credit terms had become less favourable, in addition to the tightening of non-price credit terms due to the implementation of new regulatory requirements on margins for non-cleared OTC derivatives.”
“Credit terms are expected to tighten further for all types of counterparty over the next three-month reference period, between March and May 2017.”
The report continued: “Looking at patterns in credit terms over a longer horizon, compared with one year ago responses indicated less favourable overall credit terms for all types of counterparty except banks and dealers.”
“The tightening of credit terms was more pronounced with respect to non-price terms than for price terms. Also, overall credit terms for secured funding tightened year-on-year when government bonds, high-yield corporate bonds or equities were used as collateral.”
Securities finance market participants have previously pointed to the slew of new regulatory requirements for higher liquidity for bank and non-bank balance sheets as an acute stress point behind the overall market liquidity deterioration.
The ECB’s own asset purchase programme has also been criticised for only supporting a limited securities lending programme to release these securities back into circulation.
The central bank has cut its monthly purchase target from €80 billion worth of government bonds to €60 billion, as of 1 April.
It also loosened its rules on eurosystem central banks’ ability to accept cash collateral in their public sector purchase programme’s (PSPP) securities lending facilities, without having to reinvest it in a ‘cash-neutral manner’.
The International Capital Market Association’s (ICMA) second quarterly report on market practice and regulation for 2017 noted: “In the weeks leading up to [the March] quarter-end, the market had shown a high degree of uncertainty and nervousness, with repo rates being priced very wide (and with general collateral trading below -3 percent)”.
Although general collateral and special rates were tighter than what is normally considered comfortable, it was “nothing as dramatic as seen over the 2016 year-end,” ICMA added.
“This should not be surprising, given the extreme levels seen at the end of December, and the relatively asymmetrical risks related to anticipating demand and supply imbalances over statement dates.”
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