We all know the story in the public repo market. The European Central Bank has provided three years worth of funding against the widest range of collateral it has ever dared to accept, and is preparing to do it all again in February. We know the type of collateral it accepted, and how much funding it provided.
But what, pray tell, is the story in the private interbank repo market?
According to the European Repo Council, which has just released its bi-annual repo market survey, there have been a number of interesting developments.
Among the most intriguing, according to Richard Comotto, the report’s author, is the shift in the type of collateral being used in the market, specifically the decrease of the use of both German and Italian bonds.
As the ERC’s press release notes (our emphasis):
Heightened risk-aversion among investors was evident in changes in the collateral composition of the market. Overall, the share of government bonds within the pool of EU originated collateral rebounded in this most recent survey to 79.1% of the market from 74.3% in the previous survey. The market share of German collateral continued to fall, touching 20.9% of the total (from 24.9% in December 2010), as risk averse investors became more cautious about lending these safe haven securities. The share of Italian collateral also fell to 7.0% (from 10.3% in the December 2010 survey) probably reflecting credit concerns.
The decline in the use of German and Italian government bonds as collateral, meanwhile, has come alongside a general rise in the use of government bonds. That’s against a repo-market which has stayed rougly flat in terms of size, coming in at €6,204bn in December 2011 versus €6,124bn in June 2011.
As the report’s conclusion states:
The rebound in the overall share of government securities in the main survey and in tri-party repo may be evidence of greater risk aversion. This is also evident in the continued reduction in the use of German government securities, which seem to have been hoarded as a safe-haven asset that investors were reluctant to lend. To some extent, collateral issued by smaller core Eurozone members has taken up the slack. UK and Japanese collateral may have benefited from safe haven status.
Spanish collateral has retained its market share, reflecting the success of Spanish banks in maintaining access to term funding by using CCP-cleared trading, as well as greater confidence in Spain than in other peripheral eurozone members, although anecdotal evidence suggests the horizon of term funding in Spain has shortened to about one month.
Meanwhile, with regards to the impact of the ECB’s LTRO on the market:
Godfried De Vidts, Chairman of ICMA’s European Repo Council said: “The survey demonstrates that the European repo market, an essential source of bank financing in Europe, has been able to maintain its stability during challenging market conditions up to the early part of December. The survey was taken ahead of the three year liquidity provisions of the Eurosystem and anecdotal evidence points to a slowdown in the interbank repo market since. As a community we are sure that the Eurosystem will look at all impacts of this welcome intervention, including the increasing lock-up within the Eurosystem of an important part of the available collateral.”
As Comotto told FT Alphaville on Wednesday, the pattern we’re seeing seems to be that the very best European collateral — German government bonds — is being hoarded for a rainy day (kept out of the market), while the cheapest-to-deliver (the worst quality) is what’s finding its way into the ECB collateral ‘lock-up’.
That has led the overall private market to depend increasingly on other types of ‘good’ and ‘liquid’ collateral, such as UK bonds, Japanese bonds, and the bonds of smaller core Eurozone members for day to day operations.
You could say it’s Gresham’s law in action — bad money pushing out the good, with a bit of mediocrity reigning in between.
Though, the real impact from the LTRO itself is still being assessed, says Comotto. It’s not clear, for example, if it’s been beneficial or detrimental to the functioning of the private repo market as a whole yet.
Either way, here’s how the collateral numbers stacked up back in December 2011:
Another trend highlighted by the report which is also worth mentioning is that there was another marked shift towards longer duration repo — especially for transactions of more than 12 months:
As the survey notes:
The shift in maturities seen in the last survey continued. Short dates continued to contract (to a record low of 48.1% from 50.9%) and transactions with more than a year remaining to maturity continued to expand (to a record high of 12.7% from 8.7%). Forward-forward repos remain at historically high levels (9.6% compared to 9.5%).
We wondered how that reconciled with data from repo broker Icap, who in November observed the opposite trend, a push towards shorter maturities.
According to Comotto, electronic repo deals have always tended to focus on shorter durations while the bilateral markets, being much more bespoke and private, are much more likely to cater to longer durations.
Thus, the trend towards longer duration is firmly a bilateral market trend, while deals transacted through electronic markets are potentially getting shorter.
For more exciting repo trends see the full report here.
Related links:
European repo turns to Japan – FT Alphaville
One man’s haircut is another man’s unsecured risk – FT Alphaville
Pawnbrokers of last resort: when a pound of flesh is not enough – FT Alphaville