Repo and Collateral Markets
Repo and Collateral Markets by Andy Hill, Alexander Westphal, Zhan Chen and Lisa Cleary
The second ICMA ERCC buy-side workshop On 11 May 2022, the ICMA European Repo and Collateral Council (ERCC) held its second buy-side workshop. This was intended to build on the previous buy-side workshop (9 February 2022), bringing ERCC Committee sell-side members into the conversation with a focus on the role of and challenges facing bank intermediation. ERCC Committee financial market infrastructures (FMIs) were also invited to provide input on their role in facilitating buy-side market access. A number of key observations were raised by participants through the discussions. (i) Banks need to manage various internal liquidity requirements, such as LCR and NSFR, and do so with varying degrees of sophistication. An additional complication is where large banks have been divided into a number of smaller entities in order to provide access into different jurisdictions. Whereas previously the bank would have managed one large pool of liquidity, they now have multiple, smaller pools, each with its own regulatory requirements. This creates additional complexities and limitations on banks’ abilities to provide liquidity to the market. (ii) This is made even more complex as a result of varying jurisdictional regulatory requirements impacting different regional entities within the banking group. This also means that banks have the added obligation to articulate to their client base what the various binding constraints are on their ability to provide liquidity, which can vary depending on the domicile of the counterparty. However, understanding this can in some instances provide opportunities, whether for banks to deploy balance sheet profitably, or for buy sides to enjoy advantageous pricing. A further consideration is that repo businesses do not operate in isolation and are part of a bigger ecosystem within the bank, meaning that internal capital constraints can also change, sometimes quite suddenly and significantly. PAGE 47 | IS S U E 66 | THIRD QUARTER 2022 | ICMAGROUP.ORG
(iii) An additional consideration identified is the importance of where the repo desk sits within the structure of the bank. For example, this could be part of the treasury function, or a standalone trading desk within the securities franchise. This will alter the lens through which the desk will assess different trading opportunities and how it deploys marginal balance sheet. Understanding the operational model of their bank counterparties can also be challenging for buy sides. (iv) Buy sides are inherently reactive to banks’ liquidity provision and their binding constraints, and what they experience is a very complex set of factors affecting this, which Is not easy to navigate. This becomes even more challenging when they need liquidity most: coming up to reporting dates or during a crisis. This is also when the banks are most restricted. The number one priority is to ensure access to liquidity at all times, and that is the biggest concern from a buy-side perspective, along with how to navigate the ever-evolving regulatory landscape. (v) Buy sides need to have a good understanding of the different reporting obligations of their bank counterparts, and also the timings. This does provide some pockets of liquidity, as previously highlighted, but it requires constant mapping and is also prone to change, particularly when the overall market becomes stretched, and when there may not necessarily be anywhere left to go for a price. This also explains why it is important to look at different solutions and new initiatives intended to facilitate access to liquidity, the development of which also being driven by sell-side needs. However, it is equally important to be aware of their limitations. The participants also discussed a range of related issues, including sponsored clearing solutions, counterparty onboarding, e-trading, and potential regulatory interventions to improve, or even backstop, repo market liquidity. Next steps: The ERCC intends to hold a follow-up workshop in Q3 2022 to refine the key points and perspectives of these discussions with a view to producing a white paper
