Repo to Play a ‘Pivotal’ Role in the Functioning of Markets

Repo will play a pivotal role in the functioning of financial markets in the years to come, said BNP Paribas’ Eugene McGrory. However the head of the French bank’s repo unit highlighted concerns over the impact CSDR and the leverage ratio on this market.

In his opening remarks at the Euroclear Collateral Conference McGrory noted repo stood steady in the collapse of European sovereign debt market and proved more robust alternative to unsecured markets.

With the debacle that ensued regarding libor and its relative fixings the market looked for new reference rates. “Currently are in the process of bringing to the market a secured repo reference rate, which will be based off real market data,” said McGrory. “This is another example of the importance of repo as a product and how it’s perceived both now and for many years to come.

“Repo has also been seen as a major tool by the ECB in its monetary policy as well as the established weekly and 3-monthly liquidity operations we have seen the highly successful LTROs which offered longer term liquidity of multi year duration and preferential rates.”

The newest development from the ECB has been the private sector purchase programme (the PSPP). “This is Europe’s fully-fledged QE, following in the footsteps of the US, the UK and Japan on the same path. The ECB hopes that growth and inflation will once again return,” said McGrory. “Market making bond desks will be forced to provide liquidity to the PSPP programme.

“We have seen in the sovereign crisis that having a repo market that doesn’t function properly can have adverse affects on the cash markets, making it effectively dysfunctional. With such a large project such as the PSPP that the ECB is about to embark on we felt it important to avoid such a fate. With this we are about to embark on a meeting with the ECB to explain the potential ramifications for the market and the ERC even sent a letter explaining the importance of the PSPP lending market.”

To ensure a fully functioning repo market going forward, McGrory said that potential constraints should be dealt with. “Due diligence is required to ensure we do not repeat the problems of the recent past,” he said. “As an industry we agree with transparency in the form of a central bank database. We are supportive but those in charge should be mindful of what they are looking to extract from the information.”

CSDR is a key regulation that concerns McGrory. “With the current market dynamic of sub zero interest rates, excess demand for collateral and the central bank’s PSPP programme, to throw mandatory buy ins into the mix may make the market more dysfunction as the risk of mandatory buy-in need to be factored in,” he said. “A more sensible alternative would be to have a US style TPMG fail cost, which could actually encourage better settlement discipline. At a minimum I would suggest we are explore this as a possibly first.”

However, the leverage and liquidity ratio are of the greatest concern to McGrory. “It’s clear that balance sheet is being deleveraged globally in the wake of these new regulations. In summary repo becomes ever more pivotal in today’s markets, and we need to be mindful of collateral in today’s markets as more bonds get locked away in order to buffer assets as margins for the CCP. The ability to move collateral freely between different locations is high on the agenda.”