Repo Riposte: Biggest Users Say Market Contraction No Big Deal

  • Fidelity has little angst even with volumes up to 50% lower
  • Regulation is blamed for shrinkage in funding markets

For all the concern over the shrinking size of the world’s wholesale funding markets, some of the firms that actually use them are feeling pretty relaxed.

Europe’s market is stagnating at levels 20 percent below its peak. In the U.S., the contraction of repurchase, or repo, agreements, is more like 50 percent. And some would have regulators believe that has created an accident waiting to happen. That’s because the market -- where debt securities are borrowed and lent -- is a vital cog in the world’s financial plumbing. The biggest banks rely on it for their day-to-day funding needs.

But the largest users of the market say dwindling volumes are of little concern and even offer them the chance to earn some extra revenue.

Deutsche Asset & Wealth Management says it’s confident it will be able to cope with the changes, and Fidelity Investments, the world’s largest manager of money-market mutual funds, says it has had little trouble finding high-quality short-term assets, including repurchase agreements, in which to park clients’ cash.

“Certainly we’ll acknowledge the fact that the repo market is smaller than it was pre-crisis,” Tim Huyck, chief investment officer of money markets at Boston-based Fidelity, which manages $2 trillion in assets. “Still, the universe of government securities” money funds can invest in “is enormous,” he said.

Executives including JPMorgan Chase & Co.’s Chief Executive Officer Jamie Dimon and Credit Suisse Group AG chief Tidjane Thiam have voiced concern about reduced liquidity in debt markets, to which the dwindling size of the repo markets contribute.

The arena is being compressed as a side-effect of regulators’ push to shore up the financial system and reduce the risk of a repeat of 2008’s economic crisis. The Federal Reserve Bank of New York has said that even more is needed to be done to eliminate systemic risks in wholesale funding markets.

“The market conditions where we are might not be ideal, but it’s something we can manage,” said Marco Basteck, who as a trader at $1.3 trillion Deutsche Asset & Wealth Management, helped to invest the company’s cash in the money market. “It’s getting more challenging. On the positive side, you can benefit from the situation. Asset managers can charge good premiums for lending special, or harder-to-find, collateral.”

‘Financial Edifice’

Not everyone is so confident.

Having spent more than 20 years in the repo and bond markets, Greg Markouizos, Citigroup Inc.’s global head of fixed-income finance, foresees strains on the availability of collateral.

“We have a pretty large and interconnected financial edifice that has been built over the last few years,” Markouizos said. “The ability to move collateral around the system has become integral to the functioning of the financial system. As we are restricting that that ability and as we are squeezing liquidity out of the market, there comes a point when you can have accidents.”

Europe’s market for borrowing and lending securities is around its smallest size since 2009, with the total value of outstanding contracts at 5.6 trillion euros ($6.3 trillion), a report from the International Capital Market Association published Tuesday showed. The amount financed daily through the U.S. tri-party repo system has held this year at about $1.6 trillion, after sliding 16 percent for the two years ended December 2014, data compiled by the Federal Reserve show.

“The European repo market doesn’t look very good,” said Godfried De Vidts, chairman of ICMA’s European Repo Council. “The actual state of health of the market is disguised by the excess liquidity that the banks have given current monetary policy. Bank lending is essential, but it is not happening. The banks are still deleveraging, particularly in continental Europe. Putting that all together it doesn’t paint a pretty picture.”

A slide in repo volumes and squeeze in the supply of U.S. Treasury bills is already keeping money-market rates lower than they would otherwise be as the Fed approaches its first monetary tightening since 2006.

The implementation by banks of global requirements on capital and liquidity, which has driven them to reduce low-return, asset-intensive dealings in repo agreements, may have further to roll. Barclays Plc forecasts a 20 percent drop in U.S. Treasury repo volumes over the next two years.

In Europe, tighter rules are in the works to discourage a so-called failure to deliver in repo trades. The Central Securities Depositories Regulation proposed the rules, which may take effect within 18 months. It’s a risk because it may force traders to buy securities during a volatile and illiquid period, according to Christoph Rieger, head of fixed-income research at Commerzbank AG, the biggest primary dealer for German government bonds.

The regulation could “kill the remaining liquidity in the market” as it means potential gains from a transaction may be inadequate to cover the risk of loss, Rieger said.

While that’s on the horizon, innovations may yet prevent catastrophe, and the market has so far avoided the kind of hiccup that major financial institutions fear.

“The history of Wall Street has been one of cash finding a way,” said Peter Crane, president of Crane Data, a Westborough, Massachusetts-based firm that tracks the $2.6 trillion money-market fund industry. Assets in those funds and the slice invested in repo have held fairly stable over the last five years, he said. “If there is demand someone is going to create supply.”

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