Australia’s fixed income repo market has grown in recent years as the supply of securities has ballooned following the financial crisis. The outstanding float of Australian commonwealth government bonds (ACGBs) has risen from AUD 55 billion (USD 41.98 billion) in 2007 to AUD 460 billion (USD 351 billion) today and is set to increase to more than AUD 600 billion (USD 457.89 billion) in the coming years.
Other securities, such as semi-government bonds, bank debt, supranational debt and corporate credit have also grown, and the debt market is approximately AUD 1.4 trillion (USD 1.1 trillion) in size.
The significant increase in foreign ownership of Australian debt due to both supply and the rise in demand in a low yielding environment has driven increased interest in the AUD repo market.
The repo market in Australia operates much like other repo markets globally. The central bank stands in the middle to provide or withdraw funds and provide lending on the basis of its eligible securities list. The major counterparties are the bank trading books, real money investors, central banks, hedge funds and foreign banks located both in Australia and abroad. The government’s debt borrowing arm—the Australian Office of Financial Management (AOFM)—is also involved, providing securities lending as well as its regular borrowing program of at least two nominal bond tenders per week.
Take it off the top
The largest issuers of debt in Australia are the government authorities. While the individual states have separate debt programmes to fund regional expenditure, the commonwealth government is responsible for the vast amount of both revenue and expenditure nationally and has responsibility for the major expenditure. As such, it is the largest domestic debt issuer.
In the 2016-17 financial year, the AOFM is set to issue AUD 100 billion (USD 76.8 billion) of debt. This comes after several years of sizeable deficits and borrowing programmes of between AUD 70 billion (USD 53.7 billion) to AUD 90 billion (USD 69.1 billion). We expect issuance to be maintained at between AUD 80 billion (USD 61.4 billion) and AUD 100 billion (USD 76.8 billion) over the next three years.
The market has become flush with bonds at a time when balance sheets have become pressured by regulatory changes around the size of trading inventory. A contemporaneous decline in the foreign holdings of Australian government debt has meant the domestic market has had to soak up an ever larger supply. Regulatory demand for high-quality liquid assets has gone some way to helping with this, but it too appears to be reaching limits.
Lastly, lower returns in fixed income markets have forced both active and passive investors into yield enhancement strategies that have continued to drive financing costs higher.
Put your money where your rate is
Repo rates, therefore, have traded at the higher end of the range to the cash rate in recent months. Historically, the repo rate oscillated in a range of 3 basis points (bps) to 8 bps above the cash rate. Since the middle of 2016 the repo rate has traded between 25 bps to 33 bps above cash. This cost of funding has remained elevated since the middle of 2016 and has not managed to fall sustainably at any stage.
An unusual quirk for the Australian market is that lenders of cash are paid more via the repo market than in the unsecured cash market. This has led to cash rich funds and bank treasuries (those who may have disposed of an asset) to lend cash via repo and take advantage of the rates repo offers over unsecured lending.
The term market for repo has never fully developed into offering long tenor trades as seen in the US, Japan or Europe. Typically, terms are out to one week, with periods beyond one month only growing in recent history. The high capital costs for banks operating in Australia (as opposed to broker/dealers), has limited the growth of the repo market. Flow is thus concentrated in a handful of liquidity providers.
While the holdings of ACGBs by foreign investors have fallen in percentage terms due to increased supply, the absolute level of holdings has risen. So too have holdings in credit paper as investors who sought yield and security, something the Australian market has been able to offer. The total amount of securities under repo with the the Reserve Bank of Australia has doubled in the past three years to close to AUD 140 billion (USD 107.43 billion).
In this regard, ANZ has committed resources to the repo market with two full time repo traders and one repo sales person based in Sydney. ANZ is also able to offer repo to its customers via its global offices.
ANZ Research publishes weekly views on the repo market. Please contact Hugh Leonard or local your ANZ representative for access.