EU repo market performed under pressure, report shows
23 April 2020 London
Image: optimarc / Shutterstock
European repo markets managed to weather the COVID-19 crisis relatively well despite several operational and technical challenges, according to data from the latest International Capital Markets Association (ICMA) report.
ICMA says the market functioned “relatively well through the COVID-19 crisis so far, although this is in the face of a number of constraints, not least on banks’ capacity to intermediate at a time of heightened demand, and which again highlights the dependence of market functioning on central bank intervention”.
The association adds that the market disruption in late February and March has also thrown out a number of technical and operational challenges, including collateral bottlenecks, increased settlement fails, and challenges managing intraday liquidity and collateral.
ICMA’s European Repo and Collateral Council (ERCC) conducted a snap repo survey at the end of March to ascertain changes in banks’ balance sheets during the crisis, which gathered data from 22 participants, down from its usual 60+ respondents.
The data suggests that most larger banks did increase their balances through March, although many smaller banks simultaneously reduced their repo footprint, in some cases dramatically.
Banks further report that in light of the heightened volatility, it was more a case of risk-weighted assets (RWA) limits becoming the binding constraint on business, rather than the leverage ratio, particularly for one-directional business flows (such as net borrowers of cash), ICMA says.
Meanwhile, buy-side participants reported increased reliance on the repo market as outflows drove the need to generate cash against holdings, as well as to meet margin calls against derivatives positions as volatility increased.
Buy-side data suggest that while they were successfully able to manage their liquidity through the early part of March this, unsurprisingly, became more challenging as banks reduced their repo capacity.
While collateral faced challenges due to limits on banks capacity, survey respondents also note that as market conditions worsened, lending securities became a “second-order priority” as they coped with more immediate demands.
This included sovereign wealth funds and central banks and therefore affected the supply of high-quality assets, as well as lower-grade securities.
Elsewhere, ICMA’s report notes that the launch of the European Central Bank’s Pandemic Emergency Purchase Programme (PEPP) on 18 March “marked the nadir of the crisis” and followed a record day of volumes for very short-dated German general collateral.
Andy Hill, senior director at ICMA and the report’s author, says: “While we appear to be through the worst of the turbulence, it will be important to remain vigilant in monitoring how the market continues to perform, and how it fulfills its multiple roles in underpinning the smooth function of the financial markets.”
Other highlights of the report include:
> There are widespread reports of a significant increase in settlement fails during the peak of the turbulence, with some reporting average daily fails increasing by a factor of four-to-five times normal rates, and spread across a broad range of asset classes.
> The marked fails spike appears to be attributable reductions in the supply of specific securities as the crisis deepened, and secondly operation challenges as firms adjusted to working remotely. Participants talk of problems contacting clients to confirm settlement instructions and technical delays in processing trades as a result of more manual intervention.
> A number of banks have suggested that one of the impacts of the market turbulence has been a widening of haircuts, reversing a trend over the past months.
> Market stakeholders also flag challenges related to managing the margin process during increased volatility, particularly with respect to different processes and timings across different margin arrangements: cleared, uncleared, derivatives, exchanges, bilateral, etc.
ICMA says the market functioned “relatively well through the COVID-19 crisis so far, although this is in the face of a number of constraints, not least on banks’ capacity to intermediate at a time of heightened demand, and which again highlights the dependence of market functioning on central bank intervention”.
The association adds that the market disruption in late February and March has also thrown out a number of technical and operational challenges, including collateral bottlenecks, increased settlement fails, and challenges managing intraday liquidity and collateral.
ICMA’s European Repo and Collateral Council (ERCC) conducted a snap repo survey at the end of March to ascertain changes in banks’ balance sheets during the crisis, which gathered data from 22 participants, down from its usual 60+ respondents.
The data suggests that most larger banks did increase their balances through March, although many smaller banks simultaneously reduced their repo footprint, in some cases dramatically.
Banks further report that in light of the heightened volatility, it was more a case of risk-weighted assets (RWA) limits becoming the binding constraint on business, rather than the leverage ratio, particularly for one-directional business flows (such as net borrowers of cash), ICMA says.
Meanwhile, buy-side participants reported increased reliance on the repo market as outflows drove the need to generate cash against holdings, as well as to meet margin calls against derivatives positions as volatility increased.
Buy-side data suggest that while they were successfully able to manage their liquidity through the early part of March this, unsurprisingly, became more challenging as banks reduced their repo capacity.
While collateral faced challenges due to limits on banks capacity, survey respondents also note that as market conditions worsened, lending securities became a “second-order priority” as they coped with more immediate demands.
This included sovereign wealth funds and central banks and therefore affected the supply of high-quality assets, as well as lower-grade securities.
Elsewhere, ICMA’s report notes that the launch of the European Central Bank’s Pandemic Emergency Purchase Programme (PEPP) on 18 March “marked the nadir of the crisis” and followed a record day of volumes for very short-dated German general collateral.
Andy Hill, senior director at ICMA and the report’s author, says: “While we appear to be through the worst of the turbulence, it will be important to remain vigilant in monitoring how the market continues to perform, and how it fulfills its multiple roles in underpinning the smooth function of the financial markets.”
Other highlights of the report include:
> There are widespread reports of a significant increase in settlement fails during the peak of the turbulence, with some reporting average daily fails increasing by a factor of four-to-five times normal rates, and spread across a broad range of asset classes.
> The marked fails spike appears to be attributable reductions in the supply of specific securities as the crisis deepened, and secondly operation challenges as firms adjusted to working remotely. Participants talk of problems contacting clients to confirm settlement instructions and technical delays in processing trades as a result of more manual intervention.
> A number of banks have suggested that one of the impacts of the market turbulence has been a widening of haircuts, reversing a trend over the past months.
> Market stakeholders also flag challenges related to managing the margin process during increased volatility, particularly with respect to different processes and timings across different margin arrangements: cleared, uncleared, derivatives, exchanges, bilateral, etc.
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