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Friday, May 09, 2014 8:38:33 AM

Radical change to repo markets will benefit buy-side - ERC

The repo markets are undergoing a “fundamental” change that will make it easier for buy-side firms to access collateral to meet their OTC derivatives central clearing obligations, according to Godfried De Vidts, chairman, International Capital Market Association’s European Repo Council (ERC).

Tri-party repo agreements – used by institutional investors to source the collateral they need to post initial margin at clearing houses to support centrally cleared swaps deals – are a growing element of the overall repo market, said De Widts.

“Tri-party repo is effectively a form of collateral management outsourcing for the buy-side. Whether you talk to tri-party agents or look at our most recent repo survey, there is evidence of enormous growth in the participation of the buy-side. These are early signs that I expect to continue,” he said. “As the market for bilateral repo declines – particularly for corporate bonds – tri-party will grow more. This presents a challenge because so many organisations continue to work in silos.” 

In March, the ERC latest semi-annual survey of the European repo market reported a relatively modest increase in the market share of tri-party repo to 9.9% from 9.6%, against a backdrop of a sharp fall in the size of the overall repo market of around 8.2% from June to December 2013. The outstanding value of tri-party repo reported directly by the major tri-party agents in Europe leapt 22% to a record €1,344 billion, suggesting a lot of new buy-side firms are entering the market while traditional sell-side participants moderate their activity.

De Vidts believes that progress on market infrastructure reform, including greater interoperability between international central securities depositories (ICSDs), will facilitate further growth. 

“After 10 years of discussions, we are now actively working toward interoperability between Euroclear and Clearstream in the tri-party repo market,” he said. “Fluidity of collateral is key and we should no longer accept any kind of vertical structure that disconnects cash from collateral. There has been support from the European Central Bank (ECB), the regulators are watching and we are pushing very hard. We hope to have interoperability by no later than the end of next year.”

Interoperability is important to the buy-side because while a bank might have accounts with several ICSDs or tri-party agents a corporate or institutional investor would typically only have one. If a corporate has cash in one ICSD and the lender of collateral sits in another, they cannot connect. “There were plenty of examples during the financial crisis where liquidity could not be lent to a party that had collateral because of breaks in the system.  These back-office constraints should no longer exist,” said De Vidts, who is also director of European affairs at inter-dealer broker ICAP.  

Further structural changes that should improve “fluidity” to the benefit of the buy-side include the introduction of pan-European settlement system TARGET2-Securities, the planned move to T+2 securities settlement in October, abolition of central bank repatriation requirements in May and ECB acceptance of tri-party as a way of bringing collateral into the system. “I think we will create a better environment for the buy-side to be able to work in than exists at the moment,” said De Vidts.  

“People are starting to understand the radical impact of regulation,” he added. “In five years, the repo markets will be absolutely different from what we know now. The signs are written on the wall. But a lot of people don’t realise how fundamentally this is going to change how we work. I don’t think there is anything to be scared about. It’s just a challenge to make sure we line up the dots in the right order.” 

A full interview with De Vidts will appear in the Q2 2014 edition of The TRADE Derivatives.

Chris Hall +44 (0)20 7397 3819 chris.hall@thetrade.ltd.uk