Reforms following the financial crisis have made ti-party repo far safer, finds a report published by BNY Mellon and PWC, but even greater changes lie in store. Based on a survey of market participants, the report found that the repo markets remain in a period of dramatic transition. While concluding that regulation and ongoing reform will continue to have a major effect on wholesale funding, the report also predicts that market forces and changes in the structure and profitability of the business will have major effects on repo volumes and economics over the next few years.
The report, The Future of Wholesale Funding Markets, focuses on repo markets following the U.S. tri-party repo regulatory reforms. BNY Mellon and PWC conducted a survey of nearly 100 repo market participants across the spectrum (e.g., large dealers with matched books, collateral providers, cash investors, interdealer brokers, and potential cleared repo providers), regarding the future of wholesale funding and the use of the repo markets. This report documents their findings and conclusions and makes some predictions for the near-term future.
Overall BNY Mellon and PWC found that the period of dramatic transition for repo markets is far from over. Their survey results revealed three key drivers that will change repo over the next few years:
1. Market participants agree that adopting the recommendations of the Task Force materially improved the safety and soundness of the system. Additionally, pending regulations on collateral providers and cash investors – designed to increase safety and soundness of the broader system – will put downward pressure on repo volumes in the near term.
2. Continued high demand for HQLA to meet liquidity ratios and collateralize transactions, implies that “collateral is the new cash.” The combination of this new dynamic – the short-term downward pressure on repo volumes and likely developments that will further increase demand for HQLA (such as Money Market Reform) – implies that involvement by the Fed in the repo market, through its RRP facility, is a near certainty for the foreseeable future.
3. Expanding the availability of cleared repo services in the U.S. is the most direct path toward giving G-SIBs balance sheet relief (through netting) and addressing the Tri-party Reform’s remaining concern – fire sale risks. This, coupled with the current development of several cleared repo platforms, leads us to believe that several cleared repo solutions will likely be introduced into the U.S. market in 2016 and at least one will be successfully adopted in the near to medium term.
Consequently, the report’s authors advise that market participants take a good look at their business and operational models now if they are to accommodate and benefit from the fundamental changes still to come within wholesale funding markets:
"The change we see coming to the wholesale funding markets and broader financial industry is profound. Institutions must review their current position, understand the industry, revise business and operating models, and organize collateral capabilities around this changing environment. Regulation will continue to shape the safety of the markets, but we expect a focus on collateral management and cleared repo to be at the forefront of change, helping markets and clients alleviate pressures from risk, regulation, and operational burdens. In closing, we believe repo participants should understand the concept of collateral connectivity and the benefits that both an integrated view of custody accounts and the ability to post collateral across current boundaries (CSDs and countries) would provide to their organizations. While development of these capabilities will likely be driven by institutions with material global operations, we believe collateral connectivity is the most notable and identifiable long-term trend in the repo market that firms should begin to understand and plan for now"