By Flora McFarlane.
Several buy-side practitioners have voiced warnings about the outlook for the ‘broken’ repo market, warning that European regulators needed to address the current situation.
Speaking at the ‘IMN European Beneficial Owners Conference’ on 13 September 2017, a panel of market participants painted a cautionary picture of the business, while discussing ‘Changes in the repo market’.
At the end of 2016 repo rates fell dramatically, in an extremely volatile market with significant price dislocation. Freddie Napier, repo trader at Morgan Stanley, outlined the challenges facing the market which he said contributed to the “perfect storm”, causing the market to suffer to such an extent.
The International Capital Market Association’s (ICMA) year-end report for 2016 analysed the three key factors on the year-end breakdown: market positioning; the effects of quantitative easing compounded by an inadequate lending program; and regulatory impacts on bank intermediation.
The panellists painted a cautious outlook of the market ahead, with Napier noting it was “highly dysfunctional”, but predicting that another perfect storm is unlikely to occur. Andy Hill, director of market practice and regulatory policy at ICMA denied the market was broken, but did agree that it has become less functional.
Hill identifies the problems as stemming from the way in which liquidity is provided – currently through the banks. In this environment, market participants face the significant challenge of a lack of immediacy when sourcing the other side of a trade, alongside the demands of regulatory obligations.
UniCredit’s head of repo and collateral trading, Arne Theia, said that the use of platforms and central counterparties to help intermediate the market were “the future.”
The buy-side audience were relatively damning of the markets prospects. An audience member indicated the pressing problems with liquidity provision, revealing that he was dropping his repo balance significantly, down to £3 billion from £16 billion.
“Do not think this was a perfect storm – this was nothing,” he said. “There were no additional stresses beyond year end. I am extremely worried about the repo market; don’t be put to sleep by thinking the world will be perfect again, we have a real problem.”
Audience members raised the possibility that regulatory change would have an impact, citing the potential for deregulation in the US, as well as the Federal Reserve programs aimed at broadening access to money making activities and facilitating non-banks’ depositing of liquidity surplus. However engagement with the European Central Bank was said to be challenging and few expected regulators to tackle problems before they got worse.
“Do I think there is recognition that the market is in the state that it really is. Probably not. I think it will take a couple of ‘December 2016s’ to get to that point”, said Hill.