Repo market panel: a return to normalised market-based financing?
24 January 2023
Repo market practitioners share their views with SFT on recent trading dynamics in global repo markets, the impact of monetary tightening, automation across the repo lifecycle and new opportunities available through P2P repo
Image: stock.adobe.com/Stewart Marsden
Panellists
Andy Hill
Senior director, deputy head of market practice and regulatory policy
International Capital Markets Association
Camille McKelvey
Head of business development STP
MarketAxess Post-Trade
Ned Taylor
Global head of repo, SBL & cash prime sales
HSBC
Frank Gast
Managing director, Eurex Repo and head of sales for Europe, FIC derivatives and repo sales team
Eurex
Frank Odendall
Head of securities financing product and business development
Eurex Repo
Madina Jastromb
Head of platform, financing solutions
State Street Global Markets
How do you assess the performance of global repo markets over the past 12 months?
Andy Hill: From a European perspective, the prominent theme coming out of the semi-annual European Repo and Collateral Council (ERCC) repo market surveys is one of market growth. In June 2022, we measured the outstanding size of the European repo market to be 鈧�9,680 billion, which is a year-on-year increase of 10.9 per cent. Perhaps the most notable trend, however, has been the uptake of e-trading. According to our survey, trading on automatic trading systems increased by 18.8 per cent year-on-year, with the number of transactions on venue surging by 38.5 per cent in the first half of 2022 鈥� which seems to be mostly driven by an increase in dealer-to-client (D2C) trading. This is something we expect to continue.
Camille McKelvey: We have seen an increase in average daily volume (ADV) on the MarketAxess Repo platform and, as of November 2022, we see around US$137 billion daily in matched trades. The activity that we see is largely bilateral and this is growing as we see more and more clients looking for ways to automate their post-trade processing via our platform.
Ned Taylor: Global repo markets were volatile during 2022, given the backdrop of the liability driven investment (LDI) market, tightening of financing conditions for the commercial real estate sector, and the strengthening of the sanctions regime as a result of the war in Ukraine. There were also significant central bank rate increases for the first time in over a decade to counter inflation. Repo markets, however, remained robust but challenging.
Market participants are, therefore, focused on risk appetite 鈥� assessing risk and managing that risk 鈥� as well as market liquidity. They are also focusing on operational considerations and market architecture.
Madina Jastromb: The unprecedented series of rate hikes by the Federal Reserve, starting in March of last year, has had a profound effect on the repo markets. Investors poured cash into the short end of the curve, largely into facilities such as the Fed鈥檚 Reverse Repurchase (RRP) facility, driven by the hawkish outlook of central banks. We saw significant growth in client volumes in 2022. Towards the end of the year, and into early 2023, we started seeing clients put on some longer term trades in anticipation of a slower pace of rate hikes and improved certainty in the rate outlook. We expect that higher interest rates and the shrinking of the central bank鈥檚 balance sheet will continue to drive activity in the repo space with healthy client financing and cash investment demand.
Frank Gast: In Europe, German government bonds (bunds) are a benchmark for borrowing costs across the Eurozone, and trading in German government bonds dominated repo market volumes in 2022. Owing to tight conditions in European government bond markets, which were structurally favourable for Eurex, and client positioning in response to ECB monetary policy, trading was exacerbated by volatility following the ECB鈥檚 decision to cease net asset purchases under the Asset Purchase Program (APP), which served as a safety net for price stability. The collateral shortage in high-grade assets, especially bunds, drove up volumes in specialised transactions and put pressure on repo levels.
Particularly from the second half of August, interest rate volatility and concerns about collateral shortages led to significant activity in Eurex鈥� CCP-cleared repo markets.
In October 2022, the German Finance Agency announced that it would buy 18 bonds for its own account, purchasing 鈧�3 billion in amount in each case. This was intended to counter the excess demand on the repo markets for Federal securities and ease the pressure at the end of the year. Back in March 2022, the German Finance Agency had also tapped a bond to relieve a shortage when the impact of the war in Ukraine began to affect the repo market. Overall, the average daily volume traded in the bund Special Repo more than doubled compared with 2021.
With the ECB鈥檚 change in rhetoric in the spring of 2022 hinting at a change in monetary policy, and the first rate hikes in the summer, the yield curve steepened and provided the first short-term trading opportunities in GC Pooling in many years. Following the initial rate hike in July, an increasing number of participants re-discovered GC Pooling as a liquidity management product, not only in forward but also in short-term trades.
A comprehensive revision of the ECB鈥檚 Targeted Longer-Term Refinancing Operations (TLTROs) in October 2022 resulted in repayments of around 鈧�300 billion in November and around 鈧�450 billion in December 2022, which reduced excess liquidity. We expect activity in Eurex鈥檚 GC pooling business to increase significantly due to reduced excess liquidity, further interest rate increases and more attractive GC pooling rates for the market. As a result, we have already seen strong growth in our clearing repo markets, with an increase in maturity-adjusted volume (TAV) of approximately 55 per cent compared to 2021 across all markets. Average daily trading volumes for GC and Special Repo increased approximately 58 per cent year-over-year. The interest rate tightening cycle, which began in July 2022 and continued aggressively, resulted in greater trading opportunities.
In GC Pooling, average daily trading volumes increased by 51 per cent year-on-year. Tightening liquidity conditions in the Eurozone are causing banks to re-evaluate their sources of liquidity, and formerly inactive participants are returning to the GC Pooling market. The features of the Eurex Repo GC Pooling markets provide banks with unmatched efficiency in managing scarce financial resources compared to non-CCP cleared bilateral and triparty repo markets. Multilateral netting and preferential risk weights for qualified central counterparties (QCCPs) provide capital management benefits across all key areas.
GC pooling markets continue to be impacted by high levels of excess liquidity in the Eurozone, although a turnaround is imminent given the ECB鈥檚 recent actions on bank borrowing under the TLTRO programme, one of the main drivers of excess liquidity.
We are now in a period of 鈥渘ormalisation鈥� according to leading central bankers, transitioning from low inflation, low interest rates and abundant liquidity to a phase of rising inflation, monetary tightening and indication that G7 central banks will accelerate the unwind of their asset purchase programmes. How is this impacting repo markets?
Frank Odendall: Our strategic focus in 2023 rests on three pillars. We want to attract more buy-side customers for our centrally cleared repo markets, increase our market share in the dealer-to-dealer (D2D) Special and GC Repo segment, and support the recovery of the GC Pooling business. We are optimistic and expect not only further growth in the dealer-to-client (D2C) segment from real money clients, but we will also expand our offering to hedge funds, among others. In the D2D Special and GC Repo segment, we expect increasing volumes, for example through new balance sheet netting opportunities between the GC Pooling Triparty Settling Repo product and specials.
We are also already seeing signs of a rebound in GC Pooling volumes, given the ECB鈥檚 actions to encourage redemptions under the TLTROs and the increasing funding needs of European banks. This presents a unique opportunity to position Eurex Repo as the preferred marketplace for euro funding liquidity.
ISA Direct Indemnified has expanded our ability to serve a broader range of market participants, including hedge funds. End users and their counterparties, the dealer banks, can now benefit to a greater extent from the capital and risk management advantages of having direct access to CCP-cleared repos.
McKelvey: As seen in the latest European repo market survey, the market continues to grow and now sits at nearly 鈧�10 trillion in outstanding positions. For many decades, the repo market has played a critical role in financial markets; a well-functioning repo market is necessary to have a well-functioning bond market. As we have seen from the recent issues in the gilt repo market, it is key to have scalable, automated processes in place to cope with a sharp increase in activity. Increasing numbers of clients are using our platform to help them to scale their repo business and cope with these kinds of market disruptions.
Jastromb: Return to 鈥渘ormal鈥� interest rate levels promoted higher volumes in traditional repo markets. However, in the US the Fed RRP facility continues to absorb massive amounts of liquidity. We expect all of 2023, and some of 2024, to realise the full effect of quantitative tightening.
We have continued to expand our repo offering to clients with additional permissible collateral types, tenors, and mechanisms (e.g. sponsored and peer-to-peer constructs) and anticipate supporting more asset classes and clients in the future by creating tools that will facilitate access to a broader repo market in a cost effective manner.
Hill: 鈥淣ormalisation鈥�, and even a little bit of volatility, is healthy for the repo market. In Europe we have had several years of steady negative rates, excess liquidity and, more recently, challenges with collateral scarcity 鈥� at least for the higher end of higher quality liquid assets (HQLA). A low rate, low volatility environment also makes it difficult for repo market makers to make money as spreads get squeezed and return on balance sheet becomes anaemic, meaning less risk capital is available for supporting client financing needs, not least over reporting dates. While in theory traders should be indifferent, a positive repo curve is often a repo trader鈥檚 best friend.
Taylor: I think it is still playing out in terms of quantitative tightening (QT) and the return to a more 鈥渘ormalised鈥� market-based financing. The market got used to central banks and their associated functions being major market participants on both sides of the balance sheet 鈥� through both selling and buying bonds. There could be a few bumps in the road as excess liquidity is gradually withdrawn and both investors and borrowers reassess their business models.
How far have repo markets advanced in terms of promoting end-to-end STP from trade negotiation and execution downstream across the repo transaction lifecycle? And in improving settlement efficiency?
Jastromb: There have been advances in the adoption of new technologies in repo markets, accelerated by a combination of macroeconomic conditions, business needs, Covid-era demands and an evolving regulatory environment. While we have seen progress towards true STP, there is plenty of room for improvement. We recently introduced the peer-to-peer repo trading platform, Venturi, which empowers clients to negotiate directly with each other in real time without intermediaries. This provides both flexible front-office and streamlined post-trade tools with near real-time status updates, therefore introducing meaningful efficiencies to the repo trading process from initiation to settlement within a single provider鈥檚 network.
With regards to identifying points of operational risk and cost, human error and gaps in operational processes, we have worked closely with our clients, traders and operations teams to develop solutions with greater automation and data transparency. The objective is to improve efficiency, provide timely access to information at each point in the trade lifecycle, and to reduce costs for our clients and ourselves.
Venturi supports automated inventory upload, validation and STP to settlement once a transaction is agreed between buy-side clients, matched and guaranteed by State Street. For term trades, clients can monitor margin status in the platform and satisfy a deficit, recall excess, or initiate collateral substitution.
Taylor: There has been a lot of progress and development in the past few years, with new trading platforms and service providers, as well as better end-to-end integration, all playing a part. Much of this is still coming to fruition as market adoption increases and processes bed in and are refined. That said, there is still a lot the industry is doing, especially in terms of settlement and ongoing Central 色花堂Depositories Regulation (CSDR) considerations.
Hill: Automation and STP has been around in the interbank market for a couple of decades, while the dealer-to-client market has remained very much reliant on voice and messaging. Only now are we beginning to see this segment of the market reap the benefits of automation. More use of STP in the trading process should also help to improve settlement efficiency. However, we can not ignore that the post-trade ecosystem, at least in Europe, is not the most efficient, with multiple national central securities depositories (CSDs) and central counterparties (CCPs) 鈥� which is well documented in the work of the Giovannini group.
But the industry, with the market authorities, continues to make large strides in addressing many of these inefficiencies. A good example is the recent publication of Best Practices by the ERCC to improve settlement optimisation, including the increased use of shaping, partialling, and ICSD auto-lending and borrowing programmes, which were also mirrored by ICMA鈥檚 Secondary Market Practices Committee with respect to outright markets.
McKelvey: Although electronification is common in the inter-dealer space, the same level of adoption has not been seen in the D2C space. However, this is now starting to change. We are now seeing the buy side focusing on electronification of the whole workflow and we have been able to play a critical role in ensuring that there is a smooth transition. Having the ability to confirm all trade details as soon as practically possible after a trade has been executed is extremely important. However, owing to the contractual nature of the product in the repo market, it is also important to remember that the lifecycle, and changes across it, should be closely managed to ensure that the close leg settles on the intended settlement date. Our platform allows firms to track such changes throughout the repo lifecycle and to resolve issues when they occur, rather than when the trade closes 鈥� which could be many months or years after the start leg.
Will peer-to-peer repo play a more prominent role in 2023 and into 2024? How attractive is the P2P business model in enabling buy-side firms to negotiate and trade repo directly with non-dealer counterparties?
Odendall: Peer-to-peer is not expected to become widely established as a standalone solution, given the counterparty risk, legal complexity, and associated costs. If credit mitigation is added, where one party benefits from compensation, some use cases could be envisioned 鈥� such as an asset manager managing unrated leveraged funds that could face a highly regulated money market or pension fund.
However, this is unlikely to significantly affect the banking channel, as in the past only banks could provide funds in a timely and efficient manner in a crisis scenario. Companies on the buy side will generally withdraw from the markets in a crisis to protect their liquidity positions.
Hill: Peer-to-peer solutions have long been heralded as a potential solution to buy-side access issues, much in the same way as 鈥渁ll-to-all鈥� protocols in the underlying market. However, this is far more complex in the case of repo, given the necessary legal documentation and credit risk considerations, meaning the market lends itself naturally to a bank-centric 鈥渉ub and spoke model鈥�. But initiatives such as 鈥榮ponsored repo鈥� are potentially quite exciting and it will be interesting to see how quickly they gain traction. In the meantime, we expect the uptake of sponsored clearing to gather momentum.
Taylor: A number of alternatives to traditional bilateral buy-side dealer flows are likely to flourish and complement the traditional flows, although market participants would want to be fully apprised of any associated risks and implications. Some of the market challenges and volatility during 2022 brought this sharply into focus.
Jastromb: We see growing interest and demand for peer-to-peer relationships and expect trading volumes to grow materially in 2023 and beyond. State Street introduced a bilateral peer-to-peer programme a little over a year ago. At the end of 2022, we introduced Venturi, a breakthrough electronic peer-to-peer negotiation platform with fully-integrated triparty collateral management.
The peer-to-peer model is very attractive to the buy-side community for multiple reasons. This includes a standardised legal framework, which allows investors to transact with buy-side counterparties under a programme master repurchase agreement. It offers the opportunity for participants to negotiate directly with each other on the platform, reducing the constraints provided by banks鈥� balance sheets and diversification of counterparties, providing more financing opportunities. This also offers potential for improved economics, through lower financing costs or higher yield, given the reduced cost of balance sheet provisioning.
From our perspective, this is a valuable addition to our sponsored repo model which is still very much in demand. A peer-to-peer construct provides our clients, and our firm, with more room to facilitate and grow financing opportunities that do not rely on the bank鈥檚 balance sheet, thereby enhancing our offering to clients.
Where will you target technology investment during 2023 to deliver maximum efficiency across the repo trade lifecycle?
McKelvey: We spend a lot of time gathering feedback from our clients as to how we could improve the platform for their benefit. From this dialogue, we have been working on a solution to the manual pair-off workflow that is so common across the dealer and client community. We will also monitor regulatory developments such as CSDR and T+1 in the US markets to ensure that our platform evolves with the changing regulatory landscape.
Jastromb: In 2023, our emphasis will be on expanding our peer-to-peer platform to serve a wider range of trade structures, as well as providing clients with new sophisticated decision-making tools prior to trade entry. We aim to introduce portfolio optimisation and margin analytics modules in Venturi later this year to help clients allocate their inventory more efficiently. Our longer term vision is to streamline the process from pre-trade to settlement with minimal need for manual intervention 鈥� the optimised collateral basket is created automatically based on a client鈥檚 input and forwarded to the peer-to-peer marketplace. In addition, we will continue to refine our platform negotiation functionality, to expand the types of repo trades available on the platform, and to continue streamlining post-trade processes.
Gast: Following the migration of the GC Pooling product from TARGET 2 to T2S and from conditional to true DvP, as well as the replacement of the repo clearing system in 2022, Eurex will focus on improving its repo margin methodology. The aim is to enable our members to cross-margin between Eurex-cleared repo transactions, fixed-income and money market futures as well as OTC interest rate swaps (IRS).
Taylor: It will be where we are able to consolidate our trading infrastructure to drive efficiencies and optimisation for client trades, using more automation and electronification of trading flows.
Where do you identify opportunities for expanding repo market trading into new locations?
Taylor: We continue to focus on new market access globally and building out our repo trading capabilities in both the MENA and ASEAN regions, where we see growing local demand as well as appetite for access to these markets from global participants.
Odendall: While we have already connected several members from the US and Asia to Eurex for derivatives trading and clearing, Eurex previously only offered repo clearing to companies based in Europe. With the launch of the ISA Direct Indemnified clearing model in July 2022, we have already opened access to our repo markets to Cayman-based companies. We intend to expand membership in 2023 to banks and broker-dealers based in the US and Canada, many of which are already active participants in the European fixed-income futures and options markets.
Jastromb: We see repo market growth opportunities present across multiple regions and we intend to expand our peer repo product offering to include use of a programme Global Master Repurchase Agreement (GMRA), in addition to our programme MRA, in 2023. We are cognisant of varying settlement preferences across regions and are assessing client preferences for bilateral and triparty models. Our aim is to offer products and solutions that accommodate regional preferences and address clients鈥� priorities, costs and local regulatory requirements.
Which regulatory drivers will have the greatest impact for repo market practitioners during 2023?
Hill: There are so many, where do you start! It is often the cumulative or intersecting impacts of regulation that drive market behaviour and shape market structure. Perhaps one to watch is the increased risk weighting under the Capital Requirements Regulation (CRR3) for the uncollateralised portion of securities financing transactions (SFTs) with non-banks under the Standardised Approach. This will make the cost of trading repo with asset managers and other clients relatively more expensive, particularly for sovereign bond repo. Another potential doozy is the European Banking Authority鈥檚 (EBA鈥檚) recent clarification that open reverse-SFTs cannot be recorded as inflows under the Liquidity Coverage Ratio (LCR). This could lead to a seismic switch in the EU from using open-SFTs to rolling short-term SFTs, which will only result in increasing operational costs and risks while doing nothing to the overall LCR calculation.
Gast: The ECB has published its supervisory priorities for the period 2023-2025, and its top priority is to address the risks arising from banks鈥� high reliance on TLTRO III funding. The ECB is expected to closely examine TLTRO exit strategies to ensure banks diversify their funding structure and develop credible multi-year funding plans that address the challenges posed by changing funding conditions.
Our GC pooling funding market can play an important role in banks鈥� funding plans, with stable term repo volumes and new Net Stable Funding Ratio (NSFR) conditions.
Although this is nothing new, the regulatory leverage ratio and the treatment of repo transactions on the balance sheets of global systemically important banks (G-SIBs) continue to pose the greatest challenge for market makers when it comes to offering repo liquidity to their clients. Bank balance sheets will continue to come under pressure as clients seek repo funding solutions when the pension fund exemption from the clearing mandate expires and phases 5 and 6 of the Uncleared Margin Rules (UMR) take effect.
In this context, clearing repo transactions through multilateral netting offers unparalleled balance sheet management benefits, which can be maximised through the introduction of direct access repo clearing models by customers.
The EBA鈥檚 response to the question of the treatment of open repurchase agreements under the LCR regulation is a major blow to banks, which will now have to look for alternatives or re-document their trading conditions. The decision underscores the importance of fully reviewing and challenging regulation during the consultation period, rather than relying on an assumption that regulation is consistent with general market practice.
Another regulation that generated a lot of discussion in 2023 was the Large Exposure Regulation, which requires that for loans secured by collateral (e.g. repo transactions), the bank must report the secured portion as a loan to the issuer of the collateral. This obliges banks to continuously measure their exposure to certain collateral issuers and assess whether regulatory limits are exceeded, which is very resource intensive for banks.
The use of cleared repo products such as GC Pooling allows banks to conduct their collateralised funding operations without ever violating regulatory large exposure limits.
Jastromb: Regulators are increasingly interested in the repo market and its participants following the September 2019 funding crunch, as well as money market fund (MMF) liquidity challenges in March 2020. Recent proposals include the SEC鈥檚 central clearing requirement for US Treasury cash and repo markets, proposed amendments to Regulation Alternative Trading Systems (Reg ATS), and the recently proposed rule by the Office of Financial Research to collect daily transaction-level data on non-centrally cleared bilateral repo trades.
Since the 色花堂Financing Transactions Regulation (SFTR) implementation phase, regulator focus has shifted to the accuracy of data reporting, which requires further resources and attention from repo market participants.
Compliance with these proposals, if they are adopted, and continuing compliance with existing regulation, bears certain costs (for example, in terms of spread and cost of capital). At the same time, such regulation may provide greater transparency and market liquidity. At this juncture, regulators and market participants continue to seek the right balance between resiliency, transparency and market costs.
ICMA has canvassed the industry on three potential areas of intersection between the repo market and sustainable finance objectives: repo with green and sustainable collateral; repo with green and sustainable cash proceeds; and repo between green and sustainable counterparties. What role will sustainability criteria play in the future of repo trading?
Jastromb: The repo market facilitates the movement of cash and securities in support of market liquidity. ICMA鈥檚 effort has been critical in helping to establish a framework for a sustainable financing marketplace. Today, repo with green and sustainable collateral seems to be the most common structure as collateral can be identified and tagged. However, there are many views on 鈥榮ustainability鈥�, with measures developed internally or with data providers. Consideration for counterparty and reuse of proceeds creates complexities such as identifying and maintaining the appropriate metrics, oversight and governance.
Sustainability criteria is not one-size fits all, but it is important to define and iterate agreed standards to develop a consistent framework for measurement. As sustainable markets evolve and volumes increase, incorporating key performance indicators (KPIs) 鈥� such as ESG ratings and third-party review to encourage provision of sustainable collateral and cash in a repo transaction 鈥� will be increasingly important.
Odendall: Currently, the relative share of CCP-eligible 鈥渟ustainable鈥� collateral is still quite small, representing only about 3 per cent of the total eligible ISINs in the Eurex Repo market, including GC and Special Repo. Typical buyers, for example of green bonds, are buy-and-hold investors with no imminent need to mobilise these assets. In addition, demand for special green collateral is subdued owing to its low regulatory utility and limited use in, for example, special central bank operations.
Based on the ICMA鈥檚 findings and conclusions on green collateral, the main role of triparty agents, CCPs, and trading platforms is to contribute to the development of an efficient and transparent market for sustainable finance by supporting the financing and liquidity of sustainable assets.
As for the outlook, I expect to see a sharp increase in repo transactions related to sustainable finance. The green transition to a carbon-neutral world will require huge amounts of finance. The Climate Bonds Initiative has just adjusted its future target for green bond issuance, indicating that we will need US$5 trillion worth of annual green bond issuance globally by 2025.
Second, the introduction of the Green Asset Ratio requires banks to invest a certain percentage of their assets in green projects and green assets.
And as a third driver of growth, central banks are adjusting their collateral frameworks. For example, the ECB will limit the share of pledged assets issued by companies with a high carbon footprint. As a next step, I expect central banks to offer special terms for central bank operations with green or ESG collateral.
These factors will increase banks鈥� funding and refinancing needs and therefore provides opportunities for the repo market to play an active role.
Taylor: It is important for the development of the sustainability-linked repo market to have clarity and a consistent terminology for a rapidly evolving marketplace. The ICMA has played a key role in driving this forward.
Over several years, repo markets have been impacted by concerns over collateral shortages and reduced capacity for intermediation in the run-up to the year-end. What trends have you noted in terms of year-end positioning and the functioning of repo markets over the 2022-3 year end?
Hill: Year-end repo market pricing and liquidity are generally a focus of market attention, with the euro market proving itself particularly vulnerable to significant dislocations in recent years 鈥� and documented in the ERCC鈥檚 annual analysis since 2016. The 2022 euro 鈥渢urn鈥� was being discussed as early as the summer, with underlying concerns related to excess liquidity in the banking system, scarcity in some collateral (notably German government bonds), seasonal curbs on repo market-making capacity (mainly due to regulatory reporting requirements) and, a new twist, the ECB moving interest rates higher, taking its deposit rate above zero per cent 鈥� which is also the cap for certain reserves held at the central bank.
By late September, the implied repo rate for German collateral over the three-day turn was somewhere between 鈧琒TR-800bps and 鈧琒TR-1,000bps, prompting many stakeholders to raise concerns publicly as well as with the ECB.
However, pricing over year-end improved significantly in the weeks leading up to the date. For example, German collateral averaged around 鈧琒TR-350bps in the spot-next market on 28 December. There are several potential factors that helped to contain the extent of the year-end repo market price dislocation. These include the October announcement of the Deutsche Finanzagentur that it would make an additional 鈧�54 billion of German government bonds available on repo across 18 ISINs, the increase in the ECB鈥檚 borrowing facility against cash from 鈧�150 billion to 鈧�250 billion, and the large repayment of the TLTRO on 21 December which totalled 鈧�447.5bn.
In the case of the TLTRO, this did not in itself put much government bond collateral back into the market, but it has helped to reduce the amount of excess liquidity by close to 拢1 trillion since September. The fact that positioning for year-end began as early as August also needs to be recognised.
Taylor: On this point, we observed earlier 鈥渢erming up鈥�, or closing out of positions by borrowers, and market illiquidity at certain points in 2022 compared to previous years. This was accompanied by more netted transactions, reflecting what has been a shortage of collateral supply in the market, leading to less use of leverage. The ability to provide access to bond collateral will therefore be a key differentiator, one that links to our Prime platform aspiration.
Jastromb: The past few year-ends have been relatively quiet, with ample cash available to provide financing. In previous years, we would see collateral providers line up for year-end months in advance, but there has been significantly less recent demand. That said, we do see clients interested to finance a broader range of assets more efficiently. Clients are looking to find secured investments that improve upon the Fed's RRP rate.
State Street鈥檚 FICC Sponsored Member repo programme has been a reliable source of liquidity and financing for our clients and we expect this to remain the case. To date, we have shown a steady ability to maintain, and even increase, repo trading over spot dates when dealer balance sheets have shown declines.
Interest from current and prospective clients in our FICC Sponsored DvP, Sponsored GC through our triparty solution, and Peer-to-Peer repo solutions remains robust as cash investment opportunities move back into private markets from central bank facilities.
Gast: From September 2022 onward, there was significant excess demand for high-quality securities until the end of the year. Market participants reported that considerable stress was building up, with German government bonds in particularly high demand at year-end. However, as mentioned above, a number of interventions had a very positive effect, ultimately leading to a relatively favourable year-end performance. We identified three key interventions that helped to ease the initial collateral shortage. First, the German Finance Agency significantly increased its capacity to lend German government bonds. Second, the ECB increased its lending limits. And third, interest rate hikes and TLTRO repayments attracted a number of inactive market participants back to the market and supported the overall availability of collateral.
While we ended 2022 on a positive note, we still face the challenge of significant structural problems.鈥� For example, money market funds can only enter into reverse repos with a maximum maturity of seven days, which prevents them from hedging the year-end early. Year-end balance sheet-based bank levies are also forcing banks to reduce capacity.
Andy Hill
Senior director, deputy head of market practice and regulatory policy
International Capital Markets Association
Camille McKelvey
Head of business development STP
MarketAxess Post-Trade
Ned Taylor
Global head of repo, SBL & cash prime sales
HSBC
Frank Gast
Managing director, Eurex Repo and head of sales for Europe, FIC derivatives and repo sales team
Eurex
Frank Odendall
Head of securities financing product and business development
Eurex Repo
Madina Jastromb
Head of platform, financing solutions
State Street Global Markets
How do you assess the performance of global repo markets over the past 12 months?
Andy Hill: From a European perspective, the prominent theme coming out of the semi-annual European Repo and Collateral Council (ERCC) repo market surveys is one of market growth. In June 2022, we measured the outstanding size of the European repo market to be 鈧�9,680 billion, which is a year-on-year increase of 10.9 per cent. Perhaps the most notable trend, however, has been the uptake of e-trading. According to our survey, trading on automatic trading systems increased by 18.8 per cent year-on-year, with the number of transactions on venue surging by 38.5 per cent in the first half of 2022 鈥� which seems to be mostly driven by an increase in dealer-to-client (D2C) trading. This is something we expect to continue.
Camille McKelvey: We have seen an increase in average daily volume (ADV) on the MarketAxess Repo platform and, as of November 2022, we see around US$137 billion daily in matched trades. The activity that we see is largely bilateral and this is growing as we see more and more clients looking for ways to automate their post-trade processing via our platform.
Ned Taylor: Global repo markets were volatile during 2022, given the backdrop of the liability driven investment (LDI) market, tightening of financing conditions for the commercial real estate sector, and the strengthening of the sanctions regime as a result of the war in Ukraine. There were also significant central bank rate increases for the first time in over a decade to counter inflation. Repo markets, however, remained robust but challenging.
Market participants are, therefore, focused on risk appetite 鈥� assessing risk and managing that risk 鈥� as well as market liquidity. They are also focusing on operational considerations and market architecture.
Madina Jastromb: The unprecedented series of rate hikes by the Federal Reserve, starting in March of last year, has had a profound effect on the repo markets. Investors poured cash into the short end of the curve, largely into facilities such as the Fed鈥檚 Reverse Repurchase (RRP) facility, driven by the hawkish outlook of central banks. We saw significant growth in client volumes in 2022. Towards the end of the year, and into early 2023, we started seeing clients put on some longer term trades in anticipation of a slower pace of rate hikes and improved certainty in the rate outlook. We expect that higher interest rates and the shrinking of the central bank鈥檚 balance sheet will continue to drive activity in the repo space with healthy client financing and cash investment demand.
Frank Gast: In Europe, German government bonds (bunds) are a benchmark for borrowing costs across the Eurozone, and trading in German government bonds dominated repo market volumes in 2022. Owing to tight conditions in European government bond markets, which were structurally favourable for Eurex, and client positioning in response to ECB monetary policy, trading was exacerbated by volatility following the ECB鈥檚 decision to cease net asset purchases under the Asset Purchase Program (APP), which served as a safety net for price stability. The collateral shortage in high-grade assets, especially bunds, drove up volumes in specialised transactions and put pressure on repo levels.
Particularly from the second half of August, interest rate volatility and concerns about collateral shortages led to significant activity in Eurex鈥� CCP-cleared repo markets.
In October 2022, the German Finance Agency announced that it would buy 18 bonds for its own account, purchasing 鈧�3 billion in amount in each case. This was intended to counter the excess demand on the repo markets for Federal securities and ease the pressure at the end of the year. Back in March 2022, the German Finance Agency had also tapped a bond to relieve a shortage when the impact of the war in Ukraine began to affect the repo market. Overall, the average daily volume traded in the bund Special Repo more than doubled compared with 2021.
With the ECB鈥檚 change in rhetoric in the spring of 2022 hinting at a change in monetary policy, and the first rate hikes in the summer, the yield curve steepened and provided the first short-term trading opportunities in GC Pooling in many years. Following the initial rate hike in July, an increasing number of participants re-discovered GC Pooling as a liquidity management product, not only in forward but also in short-term trades.
A comprehensive revision of the ECB鈥檚 Targeted Longer-Term Refinancing Operations (TLTROs) in October 2022 resulted in repayments of around 鈧�300 billion in November and around 鈧�450 billion in December 2022, which reduced excess liquidity. We expect activity in Eurex鈥檚 GC pooling business to increase significantly due to reduced excess liquidity, further interest rate increases and more attractive GC pooling rates for the market. As a result, we have already seen strong growth in our clearing repo markets, with an increase in maturity-adjusted volume (TAV) of approximately 55 per cent compared to 2021 across all markets. Average daily trading volumes for GC and Special Repo increased approximately 58 per cent year-over-year. The interest rate tightening cycle, which began in July 2022 and continued aggressively, resulted in greater trading opportunities.
In GC Pooling, average daily trading volumes increased by 51 per cent year-on-year. Tightening liquidity conditions in the Eurozone are causing banks to re-evaluate their sources of liquidity, and formerly inactive participants are returning to the GC Pooling market. The features of the Eurex Repo GC Pooling markets provide banks with unmatched efficiency in managing scarce financial resources compared to non-CCP cleared bilateral and triparty repo markets. Multilateral netting and preferential risk weights for qualified central counterparties (QCCPs) provide capital management benefits across all key areas.
GC pooling markets continue to be impacted by high levels of excess liquidity in the Eurozone, although a turnaround is imminent given the ECB鈥檚 recent actions on bank borrowing under the TLTRO programme, one of the main drivers of excess liquidity.
We are now in a period of 鈥渘ormalisation鈥� according to leading central bankers, transitioning from low inflation, low interest rates and abundant liquidity to a phase of rising inflation, monetary tightening and indication that G7 central banks will accelerate the unwind of their asset purchase programmes. How is this impacting repo markets?
Frank Odendall: Our strategic focus in 2023 rests on three pillars. We want to attract more buy-side customers for our centrally cleared repo markets, increase our market share in the dealer-to-dealer (D2D) Special and GC Repo segment, and support the recovery of the GC Pooling business. We are optimistic and expect not only further growth in the dealer-to-client (D2C) segment from real money clients, but we will also expand our offering to hedge funds, among others. In the D2D Special and GC Repo segment, we expect increasing volumes, for example through new balance sheet netting opportunities between the GC Pooling Triparty Settling Repo product and specials.
We are also already seeing signs of a rebound in GC Pooling volumes, given the ECB鈥檚 actions to encourage redemptions under the TLTROs and the increasing funding needs of European banks. This presents a unique opportunity to position Eurex Repo as the preferred marketplace for euro funding liquidity.
ISA Direct Indemnified has expanded our ability to serve a broader range of market participants, including hedge funds. End users and their counterparties, the dealer banks, can now benefit to a greater extent from the capital and risk management advantages of having direct access to CCP-cleared repos.
McKelvey: As seen in the latest European repo market survey, the market continues to grow and now sits at nearly 鈧�10 trillion in outstanding positions. For many decades, the repo market has played a critical role in financial markets; a well-functioning repo market is necessary to have a well-functioning bond market. As we have seen from the recent issues in the gilt repo market, it is key to have scalable, automated processes in place to cope with a sharp increase in activity. Increasing numbers of clients are using our platform to help them to scale their repo business and cope with these kinds of market disruptions.
Jastromb: Return to 鈥渘ormal鈥� interest rate levels promoted higher volumes in traditional repo markets. However, in the US the Fed RRP facility continues to absorb massive amounts of liquidity. We expect all of 2023, and some of 2024, to realise the full effect of quantitative tightening.
We have continued to expand our repo offering to clients with additional permissible collateral types, tenors, and mechanisms (e.g. sponsored and peer-to-peer constructs) and anticipate supporting more asset classes and clients in the future by creating tools that will facilitate access to a broader repo market in a cost effective manner.
Hill: 鈥淣ormalisation鈥�, and even a little bit of volatility, is healthy for the repo market. In Europe we have had several years of steady negative rates, excess liquidity and, more recently, challenges with collateral scarcity 鈥� at least for the higher end of higher quality liquid assets (HQLA). A low rate, low volatility environment also makes it difficult for repo market makers to make money as spreads get squeezed and return on balance sheet becomes anaemic, meaning less risk capital is available for supporting client financing needs, not least over reporting dates. While in theory traders should be indifferent, a positive repo curve is often a repo trader鈥檚 best friend.
Taylor: I think it is still playing out in terms of quantitative tightening (QT) and the return to a more 鈥渘ormalised鈥� market-based financing. The market got used to central banks and their associated functions being major market participants on both sides of the balance sheet 鈥� through both selling and buying bonds. There could be a few bumps in the road as excess liquidity is gradually withdrawn and both investors and borrowers reassess their business models.
How far have repo markets advanced in terms of promoting end-to-end STP from trade negotiation and execution downstream across the repo transaction lifecycle? And in improving settlement efficiency?
Jastromb: There have been advances in the adoption of new technologies in repo markets, accelerated by a combination of macroeconomic conditions, business needs, Covid-era demands and an evolving regulatory environment. While we have seen progress towards true STP, there is plenty of room for improvement. We recently introduced the peer-to-peer repo trading platform, Venturi, which empowers clients to negotiate directly with each other in real time without intermediaries. This provides both flexible front-office and streamlined post-trade tools with near real-time status updates, therefore introducing meaningful efficiencies to the repo trading process from initiation to settlement within a single provider鈥檚 network.
With regards to identifying points of operational risk and cost, human error and gaps in operational processes, we have worked closely with our clients, traders and operations teams to develop solutions with greater automation and data transparency. The objective is to improve efficiency, provide timely access to information at each point in the trade lifecycle, and to reduce costs for our clients and ourselves.
Venturi supports automated inventory upload, validation and STP to settlement once a transaction is agreed between buy-side clients, matched and guaranteed by State Street. For term trades, clients can monitor margin status in the platform and satisfy a deficit, recall excess, or initiate collateral substitution.
Taylor: There has been a lot of progress and development in the past few years, with new trading platforms and service providers, as well as better end-to-end integration, all playing a part. Much of this is still coming to fruition as market adoption increases and processes bed in and are refined. That said, there is still a lot the industry is doing, especially in terms of settlement and ongoing Central 色花堂Depositories Regulation (CSDR) considerations.
Hill: Automation and STP has been around in the interbank market for a couple of decades, while the dealer-to-client market has remained very much reliant on voice and messaging. Only now are we beginning to see this segment of the market reap the benefits of automation. More use of STP in the trading process should also help to improve settlement efficiency. However, we can not ignore that the post-trade ecosystem, at least in Europe, is not the most efficient, with multiple national central securities depositories (CSDs) and central counterparties (CCPs) 鈥� which is well documented in the work of the Giovannini group.
But the industry, with the market authorities, continues to make large strides in addressing many of these inefficiencies. A good example is the recent publication of Best Practices by the ERCC to improve settlement optimisation, including the increased use of shaping, partialling, and ICSD auto-lending and borrowing programmes, which were also mirrored by ICMA鈥檚 Secondary Market Practices Committee with respect to outright markets.
McKelvey: Although electronification is common in the inter-dealer space, the same level of adoption has not been seen in the D2C space. However, this is now starting to change. We are now seeing the buy side focusing on electronification of the whole workflow and we have been able to play a critical role in ensuring that there is a smooth transition. Having the ability to confirm all trade details as soon as practically possible after a trade has been executed is extremely important. However, owing to the contractual nature of the product in the repo market, it is also important to remember that the lifecycle, and changes across it, should be closely managed to ensure that the close leg settles on the intended settlement date. Our platform allows firms to track such changes throughout the repo lifecycle and to resolve issues when they occur, rather than when the trade closes 鈥� which could be many months or years after the start leg.
Will peer-to-peer repo play a more prominent role in 2023 and into 2024? How attractive is the P2P business model in enabling buy-side firms to negotiate and trade repo directly with non-dealer counterparties?
Odendall: Peer-to-peer is not expected to become widely established as a standalone solution, given the counterparty risk, legal complexity, and associated costs. If credit mitigation is added, where one party benefits from compensation, some use cases could be envisioned 鈥� such as an asset manager managing unrated leveraged funds that could face a highly regulated money market or pension fund.
However, this is unlikely to significantly affect the banking channel, as in the past only banks could provide funds in a timely and efficient manner in a crisis scenario. Companies on the buy side will generally withdraw from the markets in a crisis to protect their liquidity positions.
Hill: Peer-to-peer solutions have long been heralded as a potential solution to buy-side access issues, much in the same way as 鈥渁ll-to-all鈥� protocols in the underlying market. However, this is far more complex in the case of repo, given the necessary legal documentation and credit risk considerations, meaning the market lends itself naturally to a bank-centric 鈥渉ub and spoke model鈥�. But initiatives such as 鈥榮ponsored repo鈥� are potentially quite exciting and it will be interesting to see how quickly they gain traction. In the meantime, we expect the uptake of sponsored clearing to gather momentum.
Taylor: A number of alternatives to traditional bilateral buy-side dealer flows are likely to flourish and complement the traditional flows, although market participants would want to be fully apprised of any associated risks and implications. Some of the market challenges and volatility during 2022 brought this sharply into focus.
Jastromb: We see growing interest and demand for peer-to-peer relationships and expect trading volumes to grow materially in 2023 and beyond. State Street introduced a bilateral peer-to-peer programme a little over a year ago. At the end of 2022, we introduced Venturi, a breakthrough electronic peer-to-peer negotiation platform with fully-integrated triparty collateral management.
The peer-to-peer model is very attractive to the buy-side community for multiple reasons. This includes a standardised legal framework, which allows investors to transact with buy-side counterparties under a programme master repurchase agreement. It offers the opportunity for participants to negotiate directly with each other on the platform, reducing the constraints provided by banks鈥� balance sheets and diversification of counterparties, providing more financing opportunities. This also offers potential for improved economics, through lower financing costs or higher yield, given the reduced cost of balance sheet provisioning.
From our perspective, this is a valuable addition to our sponsored repo model which is still very much in demand. A peer-to-peer construct provides our clients, and our firm, with more room to facilitate and grow financing opportunities that do not rely on the bank鈥檚 balance sheet, thereby enhancing our offering to clients.
Where will you target technology investment during 2023 to deliver maximum efficiency across the repo trade lifecycle?
McKelvey: We spend a lot of time gathering feedback from our clients as to how we could improve the platform for their benefit. From this dialogue, we have been working on a solution to the manual pair-off workflow that is so common across the dealer and client community. We will also monitor regulatory developments such as CSDR and T+1 in the US markets to ensure that our platform evolves with the changing regulatory landscape.
Jastromb: In 2023, our emphasis will be on expanding our peer-to-peer platform to serve a wider range of trade structures, as well as providing clients with new sophisticated decision-making tools prior to trade entry. We aim to introduce portfolio optimisation and margin analytics modules in Venturi later this year to help clients allocate their inventory more efficiently. Our longer term vision is to streamline the process from pre-trade to settlement with minimal need for manual intervention 鈥� the optimised collateral basket is created automatically based on a client鈥檚 input and forwarded to the peer-to-peer marketplace. In addition, we will continue to refine our platform negotiation functionality, to expand the types of repo trades available on the platform, and to continue streamlining post-trade processes.
Gast: Following the migration of the GC Pooling product from TARGET 2 to T2S and from conditional to true DvP, as well as the replacement of the repo clearing system in 2022, Eurex will focus on improving its repo margin methodology. The aim is to enable our members to cross-margin between Eurex-cleared repo transactions, fixed-income and money market futures as well as OTC interest rate swaps (IRS).
Taylor: It will be where we are able to consolidate our trading infrastructure to drive efficiencies and optimisation for client trades, using more automation and electronification of trading flows.
Where do you identify opportunities for expanding repo market trading into new locations?
Taylor: We continue to focus on new market access globally and building out our repo trading capabilities in both the MENA and ASEAN regions, where we see growing local demand as well as appetite for access to these markets from global participants.
Odendall: While we have already connected several members from the US and Asia to Eurex for derivatives trading and clearing, Eurex previously only offered repo clearing to companies based in Europe. With the launch of the ISA Direct Indemnified clearing model in July 2022, we have already opened access to our repo markets to Cayman-based companies. We intend to expand membership in 2023 to banks and broker-dealers based in the US and Canada, many of which are already active participants in the European fixed-income futures and options markets.
Jastromb: We see repo market growth opportunities present across multiple regions and we intend to expand our peer repo product offering to include use of a programme Global Master Repurchase Agreement (GMRA), in addition to our programme MRA, in 2023. We are cognisant of varying settlement preferences across regions and are assessing client preferences for bilateral and triparty models. Our aim is to offer products and solutions that accommodate regional preferences and address clients鈥� priorities, costs and local regulatory requirements.
Which regulatory drivers will have the greatest impact for repo market practitioners during 2023?
Hill: There are so many, where do you start! It is often the cumulative or intersecting impacts of regulation that drive market behaviour and shape market structure. Perhaps one to watch is the increased risk weighting under the Capital Requirements Regulation (CRR3) for the uncollateralised portion of securities financing transactions (SFTs) with non-banks under the Standardised Approach. This will make the cost of trading repo with asset managers and other clients relatively more expensive, particularly for sovereign bond repo. Another potential doozy is the European Banking Authority鈥檚 (EBA鈥檚) recent clarification that open reverse-SFTs cannot be recorded as inflows under the Liquidity Coverage Ratio (LCR). This could lead to a seismic switch in the EU from using open-SFTs to rolling short-term SFTs, which will only result in increasing operational costs and risks while doing nothing to the overall LCR calculation.
Gast: The ECB has published its supervisory priorities for the period 2023-2025, and its top priority is to address the risks arising from banks鈥� high reliance on TLTRO III funding. The ECB is expected to closely examine TLTRO exit strategies to ensure banks diversify their funding structure and develop credible multi-year funding plans that address the challenges posed by changing funding conditions.
Our GC pooling funding market can play an important role in banks鈥� funding plans, with stable term repo volumes and new Net Stable Funding Ratio (NSFR) conditions.
Although this is nothing new, the regulatory leverage ratio and the treatment of repo transactions on the balance sheets of global systemically important banks (G-SIBs) continue to pose the greatest challenge for market makers when it comes to offering repo liquidity to their clients. Bank balance sheets will continue to come under pressure as clients seek repo funding solutions when the pension fund exemption from the clearing mandate expires and phases 5 and 6 of the Uncleared Margin Rules (UMR) take effect.
In this context, clearing repo transactions through multilateral netting offers unparalleled balance sheet management benefits, which can be maximised through the introduction of direct access repo clearing models by customers.
The EBA鈥檚 response to the question of the treatment of open repurchase agreements under the LCR regulation is a major blow to banks, which will now have to look for alternatives or re-document their trading conditions. The decision underscores the importance of fully reviewing and challenging regulation during the consultation period, rather than relying on an assumption that regulation is consistent with general market practice.
Another regulation that generated a lot of discussion in 2023 was the Large Exposure Regulation, which requires that for loans secured by collateral (e.g. repo transactions), the bank must report the secured portion as a loan to the issuer of the collateral. This obliges banks to continuously measure their exposure to certain collateral issuers and assess whether regulatory limits are exceeded, which is very resource intensive for banks.
The use of cleared repo products such as GC Pooling allows banks to conduct their collateralised funding operations without ever violating regulatory large exposure limits.
Jastromb: Regulators are increasingly interested in the repo market and its participants following the September 2019 funding crunch, as well as money market fund (MMF) liquidity challenges in March 2020. Recent proposals include the SEC鈥檚 central clearing requirement for US Treasury cash and repo markets, proposed amendments to Regulation Alternative Trading Systems (Reg ATS), and the recently proposed rule by the Office of Financial Research to collect daily transaction-level data on non-centrally cleared bilateral repo trades.
Since the 色花堂Financing Transactions Regulation (SFTR) implementation phase, regulator focus has shifted to the accuracy of data reporting, which requires further resources and attention from repo market participants.
Compliance with these proposals, if they are adopted, and continuing compliance with existing regulation, bears certain costs (for example, in terms of spread and cost of capital). At the same time, such regulation may provide greater transparency and market liquidity. At this juncture, regulators and market participants continue to seek the right balance between resiliency, transparency and market costs.
ICMA has canvassed the industry on three potential areas of intersection between the repo market and sustainable finance objectives: repo with green and sustainable collateral; repo with green and sustainable cash proceeds; and repo between green and sustainable counterparties. What role will sustainability criteria play in the future of repo trading?
Jastromb: The repo market facilitates the movement of cash and securities in support of market liquidity. ICMA鈥檚 effort has been critical in helping to establish a framework for a sustainable financing marketplace. Today, repo with green and sustainable collateral seems to be the most common structure as collateral can be identified and tagged. However, there are many views on 鈥榮ustainability鈥�, with measures developed internally or with data providers. Consideration for counterparty and reuse of proceeds creates complexities such as identifying and maintaining the appropriate metrics, oversight and governance.
Sustainability criteria is not one-size fits all, but it is important to define and iterate agreed standards to develop a consistent framework for measurement. As sustainable markets evolve and volumes increase, incorporating key performance indicators (KPIs) 鈥� such as ESG ratings and third-party review to encourage provision of sustainable collateral and cash in a repo transaction 鈥� will be increasingly important.
Odendall: Currently, the relative share of CCP-eligible 鈥渟ustainable鈥� collateral is still quite small, representing only about 3 per cent of the total eligible ISINs in the Eurex Repo market, including GC and Special Repo. Typical buyers, for example of green bonds, are buy-and-hold investors with no imminent need to mobilise these assets. In addition, demand for special green collateral is subdued owing to its low regulatory utility and limited use in, for example, special central bank operations.
Based on the ICMA鈥檚 findings and conclusions on green collateral, the main role of triparty agents, CCPs, and trading platforms is to contribute to the development of an efficient and transparent market for sustainable finance by supporting the financing and liquidity of sustainable assets.
As for the outlook, I expect to see a sharp increase in repo transactions related to sustainable finance. The green transition to a carbon-neutral world will require huge amounts of finance. The Climate Bonds Initiative has just adjusted its future target for green bond issuance, indicating that we will need US$5 trillion worth of annual green bond issuance globally by 2025.
Second, the introduction of the Green Asset Ratio requires banks to invest a certain percentage of their assets in green projects and green assets.
And as a third driver of growth, central banks are adjusting their collateral frameworks. For example, the ECB will limit the share of pledged assets issued by companies with a high carbon footprint. As a next step, I expect central banks to offer special terms for central bank operations with green or ESG collateral.
These factors will increase banks鈥� funding and refinancing needs and therefore provides opportunities for the repo market to play an active role.
Taylor: It is important for the development of the sustainability-linked repo market to have clarity and a consistent terminology for a rapidly evolving marketplace. The ICMA has played a key role in driving this forward.
Over several years, repo markets have been impacted by concerns over collateral shortages and reduced capacity for intermediation in the run-up to the year-end. What trends have you noted in terms of year-end positioning and the functioning of repo markets over the 2022-3 year end?
Hill: Year-end repo market pricing and liquidity are generally a focus of market attention, with the euro market proving itself particularly vulnerable to significant dislocations in recent years 鈥� and documented in the ERCC鈥檚 annual analysis since 2016. The 2022 euro 鈥渢urn鈥� was being discussed as early as the summer, with underlying concerns related to excess liquidity in the banking system, scarcity in some collateral (notably German government bonds), seasonal curbs on repo market-making capacity (mainly due to regulatory reporting requirements) and, a new twist, the ECB moving interest rates higher, taking its deposit rate above zero per cent 鈥� which is also the cap for certain reserves held at the central bank.
By late September, the implied repo rate for German collateral over the three-day turn was somewhere between 鈧琒TR-800bps and 鈧琒TR-1,000bps, prompting many stakeholders to raise concerns publicly as well as with the ECB.
However, pricing over year-end improved significantly in the weeks leading up to the date. For example, German collateral averaged around 鈧琒TR-350bps in the spot-next market on 28 December. There are several potential factors that helped to contain the extent of the year-end repo market price dislocation. These include the October announcement of the Deutsche Finanzagentur that it would make an additional 鈧�54 billion of German government bonds available on repo across 18 ISINs, the increase in the ECB鈥檚 borrowing facility against cash from 鈧�150 billion to 鈧�250 billion, and the large repayment of the TLTRO on 21 December which totalled 鈧�447.5bn.
In the case of the TLTRO, this did not in itself put much government bond collateral back into the market, but it has helped to reduce the amount of excess liquidity by close to 拢1 trillion since September. The fact that positioning for year-end began as early as August also needs to be recognised.
Taylor: On this point, we observed earlier 鈥渢erming up鈥�, or closing out of positions by borrowers, and market illiquidity at certain points in 2022 compared to previous years. This was accompanied by more netted transactions, reflecting what has been a shortage of collateral supply in the market, leading to less use of leverage. The ability to provide access to bond collateral will therefore be a key differentiator, one that links to our Prime platform aspiration.
Jastromb: The past few year-ends have been relatively quiet, with ample cash available to provide financing. In previous years, we would see collateral providers line up for year-end months in advance, but there has been significantly less recent demand. That said, we do see clients interested to finance a broader range of assets more efficiently. Clients are looking to find secured investments that improve upon the Fed's RRP rate.
State Street鈥檚 FICC Sponsored Member repo programme has been a reliable source of liquidity and financing for our clients and we expect this to remain the case. To date, we have shown a steady ability to maintain, and even increase, repo trading over spot dates when dealer balance sheets have shown declines.
Interest from current and prospective clients in our FICC Sponsored DvP, Sponsored GC through our triparty solution, and Peer-to-Peer repo solutions remains robust as cash investment opportunities move back into private markets from central bank facilities.
Gast: From September 2022 onward, there was significant excess demand for high-quality securities until the end of the year. Market participants reported that considerable stress was building up, with German government bonds in particularly high demand at year-end. However, as mentioned above, a number of interventions had a very positive effect, ultimately leading to a relatively favourable year-end performance. We identified three key interventions that helped to ease the initial collateral shortage. First, the German Finance Agency significantly increased its capacity to lend German government bonds. Second, the ECB increased its lending limits. And third, interest rate hikes and TLTRO repayments attracted a number of inactive market participants back to the market and supported the overall availability of collateral.
While we ended 2022 on a positive note, we still face the challenge of significant structural problems.鈥� For example, money market funds can only enter into reverse repos with a maximum maturity of seven days, which prevents them from hedging the year-end early. Year-end balance sheet-based bank levies are also forcing banks to reduce capacity.
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