Speakers of the session
Director, Financial Markets, DG for Financial Stability, Financial Services and Capital Markets Union, European Commission
Director, Office of Financial Research, U.S. Department of Treasury
Head of the Department Payments and Settlement Systems, Deutsche Bundesbank
MEP, Rapporteur – Recovery and Resolution of CCPs, ECR Coordinator Economic and Monetary Affairs Committee, European Parliament
President, Association of German Public Banks (VöB) & Chairman of the Management Board, Norddeutsche Landesbank (NORD/LB)
Senior Vice President, Managing Director and Chief Investment Officer, Cash, Federated Investors (UK) LLP
Managing Director, Head of European Prime Services EMEA, Credit Suisse
Chief Risk Officer, Barclays
Objectives of the sessionThis roundtable discussed the current and future trends of capital market activities, notably repo markets and market making activities, their underlying drivers and what impacts these evolutions may have on markets and on the broader economy. The regulatory approach that was needed for such markets was also addressed, as well as the means needed to monitor these activities at a European and global level.
Points of discussion
How are repo & short term securities markets and market making activities evolving, what are the likely future trends of these activities and their key underlying drivers?
- Can a significant reduction of repo, short term securities and market making activities and / or an increase of their costs be observed at present in the EU? Is the space left by large banks in these activities being taken up to a certain extent by other players? Are the trends similar in the main jurisdictions and notably the EU and the US?
- To what extent are these evolutions a consequence of the post-crisis regulatory agenda (e.g. Basel III leverage ratio, LCR…) compared to impacts of monetary policy or changes in the risk appetite of market participants? Are these structural trends? What further impacts are expected from the implementation of additional regulatory measures?
- What are the likely future evolutions of repo, short term securities and market making activities? How are their business models and the way they are sold to clients expected to change?
- What vulnerabilities may remain to be addressed regarding market making and repo activities? Should further development of repo central clearing be encouraged?
Could the on-going evolutions of repo, short term securities and market making activities have negative consequences for markets and the broader economy and are any specific actions needed in this respect?
- What are the main effects of a reduction of repo and market making for markets and the economy? What are the impacts for investors, issuers and different market participants? May a significant contraction of these activities hinder the achievement of the objectives of the CMU in any way or create new risks?
- Are any specific actions needed to address the issues created by a likely reduction of repo & short term securities markets and market making activities?
How are these developments being monitored at the EU and global levels?
- Are any specific regulatory or market-driven actions needed to improve the monitoring of repo and market-making activities?
- To what extent will the on-going actions related to SFT (SFTR in the EU) help to reduce possible data gaps regarding these activities and better assess vulnerabilities associated with them?
Background of the sessionMarket-making and repo markets both play a central role in current financial markets. Market makers who quote bid and offer prices for specific securities that they hold in inventory contribute to the robustness of liquidity by absorbing temporary supply and demand imbalances, provide immediacy services to clients and also support price discovery (notably in OTC markets). Repo markets furnish a means for short term borrowing and lending and facilitate a number of critical functions such as funding market-making books, binding many derivatives with underlying cash securities and supporting the pricing and mobilisation of collateral, therefore also contributing to market liquidity.
These activities are currently undergoing major changes which are a matter for concern in the market. The major driver of these evolutions is considered by many market observers to be the Basel III prudential banking rules. These rules aim to improve the robustness of the financial institutions performing these activities, but they have also augmented the cost of running them, thus leading to deleveraging and de-risking movements and increases in prices. Market-driven evolutions are also mentioned, notably the reduction of the risk tolerance of dealers in recent years, as well as certain impacts of the current monetary policy (QE coupled with prolonged low interest rates meaning that e.g. cash investors with access to the ECB may have less incentive to go to the market for financing or that high quality collateral is less accessible).
The supply and business model of market making is evolvingI. There has been a strong reduction of dealers’ inventories in EU and US banks notably of corporate bonds since 2008. Market making prices have increased and there is a more selective approach to clients and a concentration on core markets e.g. domestic ones. Intermediaries have also been shifting towards more order-driven and/or brokerage models that require less capital and balance sheet capacity and there is also a movement towards more electronic trading.
Repo markets have also contracted since 2008 and the larger banks in particular are reducing the size of their repo books. The business model of banks’ repo businesses is also changing according to some studies2. Netting is increasingly used to optimise the use of balance sheets. Repo desks which were previously stand-alone profit centres are increasingly becoming cost centres and are being merged with other funding functions to create centralised liquidity and collateral management hubs in order to optimize funding and margin management. Some surveys also point out that the repo market is becoming more bilateral and bespoke.
Many market observers consider that these evolutions are having major negative impacts on secondary market liquidity and increasing volatility. Regulators however point out that pre-crisis inventories or liquidity levels are not appropriate reference points and that liquidity risks need to be more closely monitored. The on-going evolutions of the business models of these activities, the role played by alternative providers to banks (e.g. buy-side market participants) or the increasing role of electronic platforms could compensate for the reduction of market-making and repo activities by banks to a certain extent, at least in normal market conditions but this still has to be further assessed over time.
The need to closely monitor the financial stability implications of Securities Financing Transactions (SFT) and notably repo activities is also emphasized by supervisors (e.g. leverage risks, liquidity and maturity mismatch risks). Evolutions are under way to improve data collection regarding these activities (e.g. with the SFTR regulation in the EU). Policy recommendations have also been published by the FSB including a framework for haircuts on non-centrally cleared SFTs.