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European repo market continues rapid growth

While the U.S. repo recovery has lagged since the 2008 crisis, the European repurchase market has been expanding for two years and rose rapidly in the first half of 2011, according to a biannual survey by the European Repo Council.

Fifty-five survey respondents reported that the value of their European repo contracts at the close of business on June 8, 2011, was $8.57 trillion. That was up from survey totals of $8.19 trillion in December 2010 and $6.42 trillion in December 2008, the post-crisis low.

From the council’s report, released last month:

The repo books of the 49 institutions that participated in all of the last three surveys grew by 3.6% over the six months from the December 2010 survey, while the surveyed business of the 53 institutions that also participated in the June 2010 survey (but not necessarily the December 2010 survey) showed year-on-year growth of 10.2%. The growth in the total value of transactions over the last six months therefore continued the upward trend reestablished in the first half of 2009 ….

By comparison, in the US the 22 Primary Dealers, who are thought to do about half of the US repurchase business (June 2012 update: They currently do about 90 percent of the business, according to the New York Fed), have recorded slower repo growth since the crisis. In June they were reporting daily volumes of $2.85 trillion, down from $2.86 trillion in December 2010 and up from a post-crisis low of $2.22 trillion in September 2009. Primary Dealers report the most complete data available on the US repurchase market.

In June Primary Dealer repo was still 38 percent below its peak on March 12, 2008, while European repo was only 9 percent below its peak on June 13, 2007. Primary Dealer repo volumes have essentially been flat for a year.

The European report includes both repo lending and borrowing, which means volumes are inflated by double counting. The Primary Dealer data is repo borrowing only. The European report does not include the value of repos transacted with central banks as part of the central banks’ official money market operations; the Primary Dealer report does.

Experts have speculated as to why the U.S. repo market is stagant while the Euopean market is thriving. Guesses at reasons for the muted US market include:

-A new FDIC fee has made repo unprofitable.
-The collapse of securitization has reduced demand for repo funding.
-Super-low interest rates make repo lending not worth the risk.
-The supply of collateral acceptable to lenders is limited.
-Uncertain markets and evolving regulations are making companies wary of leverage.

As for the booming European market, the council said in March that European banks are being drawn to the perceived safety of secured lending.

We continue to believe that repo market in Europe will become more important than ever as regulatory initiatives designed to ensure the stability of the financial system steer banks towards secured forms of lending.

Another possible reason for the repo surge in Europe is that nervous financial institutions will not lend to each other without collateral. From David Oakley, capital markets correspondent for the Financial Times, on July 3:

Interbank lending using European government bonds as collateral has reached record levels, in spite of worries over Greek debt default and the future of the eurozone.

By contrast, lending between banks without the backing of collateral has ground to a near standstill for any loans of more than a week’s duration, as fears of bank insolvency rise due to continuing uncertainty over Greece and its emergency loan payments.

Lending using collateral, which is also backed by a clearing house, ensures that a bank will get at least some of its money back in the event of a failure of the bank it has offered loans to.

In Europe, this form of short-term repurchase, or repo, lending hit daily highs of more than €220bn ($320bn) last week, as measured by the 20-day moving average – surpassing records set before the financial crisis erupted in August 2007 – according to Icap’s BrokerTec, the region’s leading electronic trading platform.

This trend towards collateralised lending, which is cleared through LCH.Clearnet, began at the start of the financial crisis in 2007, as banks either hoarded cash or insisted on the backstop of government bonds in return for their money.

When the European Repo Council releases its next survey in early 2012, it will be interesting to see if repo growth has continued during the second half of this year even though U.S. repo lenders like money market funds are fleeing.

Fifty-nine offices of 55 financial groups, mainly banks, responded to the European survey in June. Key points in the survey:

-About 17.5 percent of transactions on repo desks were securities lending, down from 18.8 percent in December.

-About 30.5 percent of outstanding repo business was cleared by a central counterparty, down from 32.3 percent.

-Concentration increased, with the top 10 companies conducting 65.5 percent of the business, up from 61.7 percent.

 -The largest categories of collateral were 37.8 percent government securities, 23.3 percent corporate bonds and 19.2 percent equities.

-Very short-term repos, of less than one-month in duration, fell to a record low of 50.9 percent of all transactions, down from 62.5 percent. From the report:

The latest survey shows evidence of the increasing volumes of longer-term  repos being negotiated by banks seeking to lock in liquidity, in part, to meet regulatory requirements. … In the latest survey, repos with remaining terms of between six months and a year increased to 6.9% from 3.6%, and transactions with more than a year remaining to maturity jumped to 8.7% from 1.0%.

In contrast, US Primary Dealers were keeping their repos short term. Their overnight repos were 66 percent of all their repurchase transactions in June, up from 64 percent in December. Reports from Primary Dealers divide repos into only two categories, overnight and term.

Many analysts have said the overnight nature of much repo lending in the US was a prime contributor to the run on repo that so dramatically intensified the financial crisis of 2007-2008.

The European Repo Council, which is part of the Zurich-based International Capital Markets Association, surveys the European repo market twice a year.

No comparable information is collected in the United States. RepoWatch has hoped the new Office of Financial Research, created by the Dodd-Frank Act, would collect and publish more complete repo statistics, but the office is still developing procedures and is not yet collecting any financial data.

The European survey  has been conducted twice a year since 2001. The next survey is scheduled to take place at close of business on December 7, 2011.

In June 2010 repo volume reported by the European Repo Council surged to $9.68 trillion, but the council said that data was distorted by one-time events.

 Correction: Some wording has been changed to show that Primary Dealer repo has grown since the crisis but not in the past year and it is not close to full recovery. Wording in an earlier version made it appear that Primary Dealer repo has been barely growing since the crisis.

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