Corporates are increasingly injecting cash into the repo market, feeding market participants need for collateral to comply with new OTC derivatives rules.
International central security depository Euroclear has found corporates are now involved in about 10% of triparty repo transactions, an increase from nearly 0% before the financial crisis.
Olivier de Schaetzen, director, product solution, global markets at Euroclear, said the number of corporates stepping in to the repo business was “quite impressive”.
“What we are observing is that corporates that used to invest cash on term-deposits with banks are looking to get away from banking risk, and the most popular solution is to invest in repo,” he said.
“This means they can continue to invest cash, but it’s done in a fully secure way. So, in the event of a banking counterparty defaulting, corporates can liquidate the collateral to get their capital back. You could say that they are moving from ‘return on capital’ to ‘return of capital’.”
Corporates have increased participation in the repo market to meet a growing demand for collateral driven by new OTC derivatives rules under the US’ Dodd-Frank Act and the European market infrastructure regulation, which requires market participants to post greater margin for derivatives trades.
The new OTC derivatives rules, coupled with new bank capital requirements under Basel III, have sparked fears of a collateral shortage.
In a report, consultancy TABB Group estimated that market participants using OTC derivatives will need to find US$1.6 trillion to US$2 trillion in additional collateral to meet new requirements.
Trend continues
Having corporates invest cash in the repo market could help banks comply with Basel III and market participants meet collateral demands.
Godfried De Vidts, chairman of the European Repo Council at the International Capital Market Association, said the large, multi-national corporates were leading the repo trend.
"It took a while for corporates to get used to the market, but it's really building up now and this trend will continue,” he said.
“There is a clear shift from banks deleveraging, doing less in the market. The banks in New York are less willing to take cash from the Federal Reserve, hence the Fed is looking to the non-banking sector. This is why the repo market will become more important than it was in the past for the non-bank sector."
Traditionally, the repo market was used by central banks to lend to the banking system. Participation has evolved with a variety of counterparties, including hedge funds and asset managers, now using the market.
De Vidts said regulators haven’t failed to notice corporates’ increased participation, with the Financial Stability Board (FSB) looking into strengthening oversight of the non-banking sector.
In August, the FSB released a report, ‘Policy framework for addressing shadow banking risks in securities lending and repos’. As part of the policy measures on the non-banking sector, the FSB this month also released a study on the framework for haircuts on securities financing transactions.
“The repo product has grown to adulthood and people are recognising it for the value it brings,” De Vidts said. “We now have a lot of regulation to work through, but I think everyone is conscious that this market is important."