The global financial system committee, which was chaired by Sir Jon Cunliffe of the Bank of England, examined the functioning of repo markets in light of recent monetary policy, focusing only on repo transactions backed by government bonds. The resulting report was delivered on 12 April.
According to the committee, repo markets are “in a state of transition and differ across jurisdictions in terms of both their structure and their functioning”.
“Exceptionally accommodative monetary policy” has played a role in providing ample central bank liquidity to the market and reducing the need for banks to trade reserves through the repo market, the committee said
But at the same time, central bank asset purchases have increased the reserves seeking investment in the repo market, “putting pressure on the balance sheets of repo intermediaries” while reducing “the quantity of high-quality collateral in many jurisdictions”.
The committee conceded “it is too soon to establish strong links between the different drivers and the observed changes in markets, or to reach clear-cut conclusions on the need for policy measures”.
A further study undertaken within the next two years was recommended, to better judge the impact of regulations that act on the size or composition of banks’ balance sheets, the treatment of collateral, permissible netting and the effects of cross-jurisdictional differences in the way repo exposures are calculated for the purpose of regulation, taxes and fees.
“Prior to such a review, authorities in some jurisdictions might consider mitigating the adverse effects of a reduction in repo availability via more targeted and temporary measures,” the committee said the report. “These include measures to reduce the scarcity of certain collateral, as well as other policies implemented in certain jurisdictions which, though initiated with the objective of facilitating monetary policy, have nonetheless improved repo market functioning.”
The study comes as European repo traders were spared another dramatic liquidity drought during the March quarter-end.
In the International Capital Market Association’s (ICMA) second quarterly report on market practice and regulation, it noted: “In the weeks leading up to quarter-end, the market had shown a high degree of uncertainty and nervousness, with repo rates being priced very wide (and with general collateral trading below -3 percent)”.
That although general collateral and special rates were tighter than what is normally considered comfortable, it was “nothing as dramatic as seen over the 2016 year-end”, ICMA added.
“This should not be surprising, given the extreme levels seen at the end of December, and the relatively asymmetrical risks related to anticipating demand and supply imbalances over statement dates.”
“However, balance sheet pressures look to be much less constrained, while the EUR-USD basis has also normalised, which is reflected in quarter-end rates settling at slightly easier levels than originally anticipated.”