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Traders fear shortage of repo collateral in Europe

Traders in Europe are worrying about a shortgage of repo collateral in the future, reports Financial News October 25.

Currently, the large number of bonds being issued by governments is filling the need, but less government spending in the future, coupled with new restrictions following the crisis of 2007-2008, are expected to put a crimp in the market, the Financial News said.

That could lead to acceptance of lesser-quality collateral, as happened in the years leading up to the crisis.

From the Financial News:

Given the volume of issuance by governments to stimulate their economies, there is currently enough supply of collateral to meet the growing demand. But the balance might tip if government issuance or liquidity dries up. A recent study by the International Monetary Fund estimated that about $4.5 trillion of bonds would be issued globally in 2010, tripling the average amount of money that the developed economies have borrowed in the past five years.

This pace will not continue. John Burke, director and head of fixed income at LCH.Clearnet, said: “We know that the rate of the increase in government supply will flatten and then decrease, and the speed with which the central banks start to reduce their debt burden will depend on the particular strategy of each country.”

Arne Theia, head of repo and collateral trading at UniCredit, said: “Going forward, there are serious doubts that issuance from governments will fulfil all the needs in the market. One of the main problems though is the regulators have yet to decide what is the definition of high-quality collateral.

“Government bonds are a significant component but the question is: Will covered bonds and bank loans be included? Also, the fragmentation of the market needs to be addressed as there is a big difference today between bonds issued from countries such as France and Germany and those of Spain, Portugal and Greece.”

Godfried de Vidts, chairman of ICMA’s European Repo Council, said: … “What might happen is that there will not be enough high-quality collateral to meet the needs of the market. We are addressing this situation by holding ongoing talks with regulators about widening the definition of high-quality collateral beyond triple A-rated securities. We are looking at using bank loans and covered bonds but they would both need to have the appropriate haircuts and risk management framework in place.” …

Some sections of the industry are lobbying for the use of equities as collateral. … John Rivett, vice-president and global head of collateral management at JP Morgan Worldwide Securities Services, agrees. He said: “Two of the main attractions of equities being used as collateral are price transparency and the ability to measure liquidity.

This is of key importance. Although equities are more expensive than government bonds, repo sellers want to know that they will be able to finance an asset on their balance sheet. Repo buyers have comfort in the knowledge that with a daily traded volume test you can be sure there is liquidity in the asset should you need to sell in the event of default.”

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