A search for liquidity
10 May 2022
Industry specialists reflect on challenges confronting buy-side firms in accessing repo markets, particularly under conditions of market stress, and what we can learn from recent experience. Carmella Haswell reports
Image: stock.adobe.com/bizvector
The repo market has become a primary means through which liquidity is sourced, priced and circulated. This integral part of the securities finance sector has been utilised for investing cash for money market funds, collateral management and for liquidity management purposes. Accessing this tool has proven difficult for some buy-side firms and the industry is now working to provide solutions for these hurdle-jump challenges.
A roundtable discussion from the International Capital Market Association’s (ICMA’s) annual general meeting reflected on the challenges that banks face in ensuring efficient use of capital and balance sheet. It noted that intermediation has many weak spots and that significant investments are required to keep the repo market working effectively.
Vanaja Indra, market and regulatory reform director at Insight Investment, emphasises the role of repo in today’s market. She says: “The repo market is important for both cash investors such as money market funds and those that may utilise repo to help manage their liquidity for purposes such as margin calls. The repo market plays a pivotal role in ‘oiling the system’ and ensuring liquidity is passed on from those who have cash to those who need it, particularly in stressed market conditions.”
Speaking from a pension fund perspective, PGGM investment manager Roelof van der Struik adds: “The repo market is one of the major tools we use for managing liquidity for our clients. When the sun is shining and the world is a nice place to be, nobody wants cash. But when the fertiliser hits the air conditioning, suddenly everyone wants cash.”
Accessing the market
There is no level playing field when it comes to accessing the repo market. According to Charlie Badran, head of AXA financing at AXA Investment Managers, it is dependent on the size of the financial institutions, whether it be a Tier 1 or 2 buy-side firm for example, and “how you are considered by your broker-dealer”.
PGGM’s Struik highlights challenges facing buy-side firms that are attempting to access the repo market, noting that the lead up to year-end and quarter-end reporting can create havoc in the market. During this period, the market simply “is not there”, he notes, and, as a result, firms will need to access liquidity through other channels.
Significantly, the buy-side is also faced with significant investments, for example in straight-through processing (STP), transaction settlement and admin, to ensure they can participate efficiently in repo markets. “It only really works if it is done through STP, especially with regards to the Securities Financing Transactions Regulation (SFTR) and Central Securities Depositories Regulation (CSDR). The list of regulations to comply with is a burden for companies including PGGM, who find regulation to be a large expenditure,” Struik explains.
However, one of the biggest challenges facing buy-side firms has been in managing their reliance on banks as intermediaries in providing repo market access. According to Insight Investment’s Indra, the key challenge is that the buy-side are at the mercy of the banks’ balance sheets and risk-weighted assets constraints. “We see the banks as playing a critical role in providing liquidity to the wider market, even in stressed conditions, because they are the only entities that intermediate between central banks and the rest of the market,” says Indra. She explains that banks are constrained by banking rules and capital adequacy requirements — and during periods of stress, banks will be more inward looking to protect their balance sheet, pulling back from some of the services that they provide.
Since the first quarter of 2020, the market has faced stress conditions resulting from the impact of the COVID-19 pandemic. Discussing the stress period of March 2020, the ICMA roundtable pinpointed some of the main takeaways from this time. For example, there was greater demand for cash from clients to meet margin calls and other liquidity needs, while at the same time these firms wished to avoid selling out of their asset holdings as these “tanked” in price. This prompted these firms to look to the repo markets to meet their liquidity requirements.
Turning his thoughts back to the events of March 2020, AXA Investment Managers’ Badran explains: “We have seen some divergence between the banks. The larger banks were increasing their balance sheet, but on the short tenor, they were not providing liquidity as usual. In times of stress, we need more liquidity and the banks should be present to provide the liquidity required not only by Tier 1 banks, but also by other buy-side institutions.”
Fortunately, intervention from the European Central Bank (ECB) in the European market offered some relief to the situation by providing “a timely reprieve for the market and temporary relief in the Leverage Ratio calculation,” says Badran. He explains: “This provided more capacity for banks, with balance sheets being relatively unconstrained, and enabled better market functioning, especially over reporting dates.”
Finding a solution
There is much that the banks and buy-side institutions can do to provide smoother access to the repo market and to be confident that banks will be able to provide a much needed service to the industry in stress conditions.
To facilitate this, AXA Investment’s Badran says clearing houses and banks are taking steps to connect the buy-side through the sponsor model, with repo clearing available from clearing houses including LCH and Eurex. “This will help the banking community to net their transactions,” explains Badran. “By netting the buy-side transaction through the CCP, it will provide more capacity to the Street, especially to the buy-side. If you are looking for collateral today and investing the cash, central clearing is a tool that buy-side institutions need to have, because good collateral in the bilateral market is really hard to find.”
The group, moderated by ICMA senior director Andy Hall, explored other possible solutions for buy-side firms struggling to access the market. During this discussion, Indra highlights three pivotal steps. She emphasises the importance of the sponsored clearing repo models and encouraged the banks and all market participants to support this service. The number of clearing members supporting this model is currently well short of where it needs to be, Indra believes.
For clearing entities, she indicates that it is important over time that these can amend their rules to make it permissible for medium-sized clients to participate in this repo clearing model. Indra comments: “We would like money market funds to be able to trade cleared repos, as that could be a helpful stabilising force in stressed conditions where money market funds can be a cash provider when the rest of the market may be needing liquidity. Unfortunately, for UK central counterparties that is not permitted post-Brexit owing to an anomaly in EU regulation.”
Additionally, Indra indicates that there is some work to be done relating to the intermediary role performed by banks. She says that it would be helpful if the banking community could take greater ownership of this issue, as a provider of a very important service to the market. “It would be good if ICMA and the banking community would collaborate to identify the minimum tweaks needed in existing bank capital rules, so that banks could confidently provide liquidity to the buy-side in stressed conditions. This would help the buy-side’s conversations with relevant policymakers on this issue,” she says.
The ICMA-organised roundtable reflected on these initiatives, presenting mixed reviews on whether CCPs would have improved the situation for the buy-side during the stresses of March 2020, and whether the benefits would justify the resultant costs.
Investment manager at PGGM Roelof van der Struik highlights the importance of extending access to repo trading platforms, underlining the value of a transparent and open marketplace where the buy-side can transact with multiple banks. Adding to this, AXA Investment’s Badran explains that in terms of an electronic platform, there are multiple vendors that are already acting within the fixed income market, within the cash market, and some vendors that are connected in the repo interbanking market. “Each buy-side or repo desk has its own demand. The trading platform should have the main functionalities, but should also widen the scope in terms of optionality like open repo, evergreen repo, multiple tenor RFQ,” he adds.
Similarly, Insight Investment’s Indra comments: “Electronic platforms can be helpful for increasing standardisation. We would expect a cleared repo model, if integrated with an electronic trading platform, to increase accessibility to, and participation in, the repo market by the buy-side. We believe this would further help participants to access liquidity when it is needed, particularly in stressed market conditions.”
Pushing the discussion forward, the panel encouraged the buy-side community to analyse the steps it should be taking to improve its access to the repo market. Once again highlighting the importance of supporting the sponsored clearing repo models through adoption, Indra believes standardisation will be key to increasing liquidity. However, Indra comments that embracing standardisation may be challenging for some buy-side firms.
On this note, PGGM’s Struik concludes that buy-side firms should be prepared to invest — as PGGM has been doing “quite vigorously”, despite the barriers of attaining the budget. He adds: “We should try to resist temptation, in the sense that if the regulator is saying ‘we do not like shadow banking, we want you to go to CCPs’, then maybe we should not invest in peer-to-peer solutions.”
A roundtable discussion from the International Capital Market Association’s (ICMA’s) annual general meeting reflected on the challenges that banks face in ensuring efficient use of capital and balance sheet. It noted that intermediation has many weak spots and that significant investments are required to keep the repo market working effectively.
Vanaja Indra, market and regulatory reform director at Insight Investment, emphasises the role of repo in today’s market. She says: “The repo market is important for both cash investors such as money market funds and those that may utilise repo to help manage their liquidity for purposes such as margin calls. The repo market plays a pivotal role in ‘oiling the system’ and ensuring liquidity is passed on from those who have cash to those who need it, particularly in stressed market conditions.”
Speaking from a pension fund perspective, PGGM investment manager Roelof van der Struik adds: “The repo market is one of the major tools we use for managing liquidity for our clients. When the sun is shining and the world is a nice place to be, nobody wants cash. But when the fertiliser hits the air conditioning, suddenly everyone wants cash.”
Accessing the market
There is no level playing field when it comes to accessing the repo market. According to Charlie Badran, head of AXA financing at AXA Investment Managers, it is dependent on the size of the financial institutions, whether it be a Tier 1 or 2 buy-side firm for example, and “how you are considered by your broker-dealer”.
PGGM’s Struik highlights challenges facing buy-side firms that are attempting to access the repo market, noting that the lead up to year-end and quarter-end reporting can create havoc in the market. During this period, the market simply “is not there”, he notes, and, as a result, firms will need to access liquidity through other channels.
Significantly, the buy-side is also faced with significant investments, for example in straight-through processing (STP), transaction settlement and admin, to ensure they can participate efficiently in repo markets. “It only really works if it is done through STP, especially with regards to the Securities Financing Transactions Regulation (SFTR) and Central Securities Depositories Regulation (CSDR). The list of regulations to comply with is a burden for companies including PGGM, who find regulation to be a large expenditure,” Struik explains.
However, one of the biggest challenges facing buy-side firms has been in managing their reliance on banks as intermediaries in providing repo market access. According to Insight Investment’s Indra, the key challenge is that the buy-side are at the mercy of the banks’ balance sheets and risk-weighted assets constraints. “We see the banks as playing a critical role in providing liquidity to the wider market, even in stressed conditions, because they are the only entities that intermediate between central banks and the rest of the market,” says Indra. She explains that banks are constrained by banking rules and capital adequacy requirements — and during periods of stress, banks will be more inward looking to protect their balance sheet, pulling back from some of the services that they provide.
Since the first quarter of 2020, the market has faced stress conditions resulting from the impact of the COVID-19 pandemic. Discussing the stress period of March 2020, the ICMA roundtable pinpointed some of the main takeaways from this time. For example, there was greater demand for cash from clients to meet margin calls and other liquidity needs, while at the same time these firms wished to avoid selling out of their asset holdings as these “tanked” in price. This prompted these firms to look to the repo markets to meet their liquidity requirements.
Turning his thoughts back to the events of March 2020, AXA Investment Managers’ Badran explains: “We have seen some divergence between the banks. The larger banks were increasing their balance sheet, but on the short tenor, they were not providing liquidity as usual. In times of stress, we need more liquidity and the banks should be present to provide the liquidity required not only by Tier 1 banks, but also by other buy-side institutions.”
Fortunately, intervention from the European Central Bank (ECB) in the European market offered some relief to the situation by providing “a timely reprieve for the market and temporary relief in the Leverage Ratio calculation,” says Badran. He explains: “This provided more capacity for banks, with balance sheets being relatively unconstrained, and enabled better market functioning, especially over reporting dates.”
Finding a solution
There is much that the banks and buy-side institutions can do to provide smoother access to the repo market and to be confident that banks will be able to provide a much needed service to the industry in stress conditions.
To facilitate this, AXA Investment’s Badran says clearing houses and banks are taking steps to connect the buy-side through the sponsor model, with repo clearing available from clearing houses including LCH and Eurex. “This will help the banking community to net their transactions,” explains Badran. “By netting the buy-side transaction through the CCP, it will provide more capacity to the Street, especially to the buy-side. If you are looking for collateral today and investing the cash, central clearing is a tool that buy-side institutions need to have, because good collateral in the bilateral market is really hard to find.”
The group, moderated by ICMA senior director Andy Hall, explored other possible solutions for buy-side firms struggling to access the market. During this discussion, Indra highlights three pivotal steps. She emphasises the importance of the sponsored clearing repo models and encouraged the banks and all market participants to support this service. The number of clearing members supporting this model is currently well short of where it needs to be, Indra believes.
For clearing entities, she indicates that it is important over time that these can amend their rules to make it permissible for medium-sized clients to participate in this repo clearing model. Indra comments: “We would like money market funds to be able to trade cleared repos, as that could be a helpful stabilising force in stressed conditions where money market funds can be a cash provider when the rest of the market may be needing liquidity. Unfortunately, for UK central counterparties that is not permitted post-Brexit owing to an anomaly in EU regulation.”
Additionally, Indra indicates that there is some work to be done relating to the intermediary role performed by banks. She says that it would be helpful if the banking community could take greater ownership of this issue, as a provider of a very important service to the market. “It would be good if ICMA and the banking community would collaborate to identify the minimum tweaks needed in existing bank capital rules, so that banks could confidently provide liquidity to the buy-side in stressed conditions. This would help the buy-side’s conversations with relevant policymakers on this issue,” she says.
The ICMA-organised roundtable reflected on these initiatives, presenting mixed reviews on whether CCPs would have improved the situation for the buy-side during the stresses of March 2020, and whether the benefits would justify the resultant costs.
Investment manager at PGGM Roelof van der Struik highlights the importance of extending access to repo trading platforms, underlining the value of a transparent and open marketplace where the buy-side can transact with multiple banks. Adding to this, AXA Investment’s Badran explains that in terms of an electronic platform, there are multiple vendors that are already acting within the fixed income market, within the cash market, and some vendors that are connected in the repo interbanking market. “Each buy-side or repo desk has its own demand. The trading platform should have the main functionalities, but should also widen the scope in terms of optionality like open repo, evergreen repo, multiple tenor RFQ,” he adds.
Similarly, Insight Investment’s Indra comments: “Electronic platforms can be helpful for increasing standardisation. We would expect a cleared repo model, if integrated with an electronic trading platform, to increase accessibility to, and participation in, the repo market by the buy-side. We believe this would further help participants to access liquidity when it is needed, particularly in stressed market conditions.”
Pushing the discussion forward, the panel encouraged the buy-side community to analyse the steps it should be taking to improve its access to the repo market. Once again highlighting the importance of supporting the sponsored clearing repo models through adoption, Indra believes standardisation will be key to increasing liquidity. However, Indra comments that embracing standardisation may be challenging for some buy-side firms.
On this note, PGGM’s Struik concludes that buy-side firms should be prepared to invest — as PGGM has been doing “quite vigorously”, despite the barriers of attaining the budget. He adds: “We should try to resist temptation, in the sense that if the regulator is saying ‘we do not like shadow banking, we want you to go to CCPs’, then maybe we should not invest in peer-to-peer solutions.”
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