Beyond the pandemic for repo markets in 2021
02 March 2021
Jeff Kidwell, president of Kidwell Consulting, offers his expert verdict on the state of the US repo market in 2021 and offers advice on what might be done to alleviate some of the pain points
Image: Jeff Kidwell
After nearly 100 million people became infected with COVID-19 and more than 2 million of them died worldwide, it would be impossible to ignore the mortal, economic, and mental toll that the pandemic has brought to millions more people in the world. It is also hard to look ahead and ‘assume’ that the disease will come under control, aided by all of the precautions and the new vaccines.
Yet, I’ve been asked to look ahead to 2021 in my crystal ball, to see what other issues we will need to focus on in the repo market, and offer up some of my thoughts for discussion. Clearly, the pandemic forced the migration of workers in our industry from the office (and the money centers) to remote locations (some of them home offices). Along with the migration of schooling and other businesses to working remotely or virtually, this migration of the repo market is probably not a temporary thing, and certain benefits were unintentionally realised by the companies. There were tax, commercial real estate, technology, meeting efficiencies, and more benefits/issues that were realised during this almost forced business continuity plan. All of that has further implications for supervision, management, office leasing, employee compensation, home computer compliance, accounting, retention of documents, etc.
I would proffer that the first issues that the repo market in 2021 must address are: are these further implications identified and being dealt with for remote trading and sales, and is our technology up to the tasks of the benefits & issues highlighted by the remote migration?
We would have liked to have by now been able to say that technology can meet all of the trading and collateral optimisation needs of remote work. But the growth of the widely-assumed move to exchange-traded products, arbitrage trading programme, and central counterparties (CCPs), has been lackluster, driven mostly by sponsored repo and industry consolidation. Focusing just on the CCP side, it seems that their very existence, to reduce systemic risk, has actually led to less transparency, more concentration risk, and a self-limiting capital cap on volumes. Is there still a market trust issue in banks or is this because these were vendor-based initiatives and not community-based initiatives?
As we look at the technology needs for the repo market in this environment, do we have enough answers for remote users for elements of the repo trade cycle? The electronic platforms would be for the quotes, enquiries, and trading. But, where are we on the settlement of trades? I read that the European Central Bank and France think this is one of several areas in the trade cycle, during the massive transfer of assets to Europe from the UK, to take the opportunity to grow a more robust financial structure in Europe, including setting up its owner operations and clearing houses. Other parts of the repo trade cycle that we need to make sure there are appropriate technology solutions for are: counterparty know-your-customer, documentation, anti-money laundering, counterparty credit risk determination and monitoring, pricing of securities, trade processing, trade confirmation, and the monitoring and completion of trades (including coupon payments, dividends, proxies, substitutions, margin maintenance calls, maturing securities, early unwinds, etc.). Of course, the repo participants have to make sure that collateral and balance sheet are being optimised.
Then, there are the regulations. Not only do we need to see if the technology is sufficient to overlay the mountain of current regulations. In 2021, the repo market may also have to deal with the specter of Financial Stability Board and Financial Stability Oversight Council shadow banking reforms, European Commission-rumored hedge fund rules, new Best Interest rules, environmental, social and governance rules, short selling bans in some countries, potentially the Volcker Rule and the Federal Reserve finally addressing the Orderly Liquidation Authority for Firesale Risk. Not to mention the European Íø±¬³Ô¹Ï and Markets Authority’s Íø±¬³Ô¹Ï Financing Transactions Regulation, Central Íø±¬³Ô¹Ï Depositories Regulation, the second Markets in Financial Instruments Directive, the European Markets Infrastructure Regulation, Rule 165, Basel III and IV, and the Financial Transaction Trax (in France and New Jersey), just to name a few.
I think another topic for 2021 that the repo market will have to deal with is the continuing imbalances of supply and liquidity, particularly in the US markets. This is somewhat due to the Fed’s zero interest rate policy, but also the imbalance of collateral suppliers (broker/dealers) due to regulations and competing balance sheet products, as well as the Fed’s own programmes, where it repos collateral to the primary dealers’ cash providers and reverse repos collateral from the primary dealers. In effect, the Fed is running a mismatched repo book, while tinkering with the underlying rates of repo, reverse repo, Fed funds, and interest on excess reserves. I’ve argued that some of those imbalances could be alleviated by having both the buy-side collateral providers execute repo with the buy-side cash providers, bypassing the handcuffed broker-dealers and the need for the Fed to intervene, but I haven’t seen the expected or potential growth in the recent figures that the overnight funding rate is reporting and that I am hearing from clients. Perhaps, it’s because there hasn’t been a community-based technological solution that makes it work better with remote trading. I think this overall supply/liquidity/counterparty diversification issue will be one of the most important for the repo market in 2021.
The last issue that comes to mind is the need for distanced continued learning, the need for distanced networking (particularly in like-minded communities), distanced tutorials and conference panels, and distanced basic training. With the pandemic forcing us from our three dozen annual conferences, because we can’t have gatherings, and the non-specific panel discussions, and the need for more direct repo issue help desks, if you will, there is a technology needed here for the new networking.
I recently became a part of two of the solutions for this growing need in 2021. I have taught the ‘fundamentals of repo’ course for the Virtual Academy designed by Pierpoint Financial, which is an intense 11-week course from my 38-years of experience in the repo industry, and which accompanies other courses in collateral management, securities lending, and others to come, taught by other experts.
The second solution I am involved in is the very adaptable Pierpoint Alpha Community, which will provide the market with experts on call who can answer member questions on any number of topics, provide tutorials, develop question-and-answer discussions, and will allow for networking of like-minded institutions to discuss the most important topics of the day.
Yet, I’ve been asked to look ahead to 2021 in my crystal ball, to see what other issues we will need to focus on in the repo market, and offer up some of my thoughts for discussion. Clearly, the pandemic forced the migration of workers in our industry from the office (and the money centers) to remote locations (some of them home offices). Along with the migration of schooling and other businesses to working remotely or virtually, this migration of the repo market is probably not a temporary thing, and certain benefits were unintentionally realised by the companies. There were tax, commercial real estate, technology, meeting efficiencies, and more benefits/issues that were realised during this almost forced business continuity plan. All of that has further implications for supervision, management, office leasing, employee compensation, home computer compliance, accounting, retention of documents, etc.
I would proffer that the first issues that the repo market in 2021 must address are: are these further implications identified and being dealt with for remote trading and sales, and is our technology up to the tasks of the benefits & issues highlighted by the remote migration?
We would have liked to have by now been able to say that technology can meet all of the trading and collateral optimisation needs of remote work. But the growth of the widely-assumed move to exchange-traded products, arbitrage trading programme, and central counterparties (CCPs), has been lackluster, driven mostly by sponsored repo and industry consolidation. Focusing just on the CCP side, it seems that their very existence, to reduce systemic risk, has actually led to less transparency, more concentration risk, and a self-limiting capital cap on volumes. Is there still a market trust issue in banks or is this because these were vendor-based initiatives and not community-based initiatives?
As we look at the technology needs for the repo market in this environment, do we have enough answers for remote users for elements of the repo trade cycle? The electronic platforms would be for the quotes, enquiries, and trading. But, where are we on the settlement of trades? I read that the European Central Bank and France think this is one of several areas in the trade cycle, during the massive transfer of assets to Europe from the UK, to take the opportunity to grow a more robust financial structure in Europe, including setting up its owner operations and clearing houses. Other parts of the repo trade cycle that we need to make sure there are appropriate technology solutions for are: counterparty know-your-customer, documentation, anti-money laundering, counterparty credit risk determination and monitoring, pricing of securities, trade processing, trade confirmation, and the monitoring and completion of trades (including coupon payments, dividends, proxies, substitutions, margin maintenance calls, maturing securities, early unwinds, etc.). Of course, the repo participants have to make sure that collateral and balance sheet are being optimised.
Then, there are the regulations. Not only do we need to see if the technology is sufficient to overlay the mountain of current regulations. In 2021, the repo market may also have to deal with the specter of Financial Stability Board and Financial Stability Oversight Council shadow banking reforms, European Commission-rumored hedge fund rules, new Best Interest rules, environmental, social and governance rules, short selling bans in some countries, potentially the Volcker Rule and the Federal Reserve finally addressing the Orderly Liquidation Authority for Firesale Risk. Not to mention the European Íø±¬³Ô¹Ï and Markets Authority’s Íø±¬³Ô¹Ï Financing Transactions Regulation, Central Íø±¬³Ô¹Ï Depositories Regulation, the second Markets in Financial Instruments Directive, the European Markets Infrastructure Regulation, Rule 165, Basel III and IV, and the Financial Transaction Trax (in France and New Jersey), just to name a few.
I think another topic for 2021 that the repo market will have to deal with is the continuing imbalances of supply and liquidity, particularly in the US markets. This is somewhat due to the Fed’s zero interest rate policy, but also the imbalance of collateral suppliers (broker/dealers) due to regulations and competing balance sheet products, as well as the Fed’s own programmes, where it repos collateral to the primary dealers’ cash providers and reverse repos collateral from the primary dealers. In effect, the Fed is running a mismatched repo book, while tinkering with the underlying rates of repo, reverse repo, Fed funds, and interest on excess reserves. I’ve argued that some of those imbalances could be alleviated by having both the buy-side collateral providers execute repo with the buy-side cash providers, bypassing the handcuffed broker-dealers and the need for the Fed to intervene, but I haven’t seen the expected or potential growth in the recent figures that the overnight funding rate is reporting and that I am hearing from clients. Perhaps, it’s because there hasn’t been a community-based technological solution that makes it work better with remote trading. I think this overall supply/liquidity/counterparty diversification issue will be one of the most important for the repo market in 2021.
The last issue that comes to mind is the need for distanced continued learning, the need for distanced networking (particularly in like-minded communities), distanced tutorials and conference panels, and distanced basic training. With the pandemic forcing us from our three dozen annual conferences, because we can’t have gatherings, and the non-specific panel discussions, and the need for more direct repo issue help desks, if you will, there is a technology needed here for the new networking.
I recently became a part of two of the solutions for this growing need in 2021. I have taught the ‘fundamentals of repo’ course for the Virtual Academy designed by Pierpoint Financial, which is an intense 11-week course from my 38-years of experience in the repo industry, and which accompanies other courses in collateral management, securities lending, and others to come, taught by other experts.
The second solution I am involved in is the very adaptable Pierpoint Alpha Community, which will provide the market with experts on call who can answer member questions on any number of topics, provide tutorials, develop question-and-answer discussions, and will allow for networking of like-minded institutions to discuss the most important topics of the day.
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