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ICMA comes out against FTT as survey shows decline in European Repo market

Europe’s repurchase (repo) market, a major source of short-term funding for banks, fell in 2012 according to the European Repo Council (ERC) of the International Capital Market Association’s (ICMA) latest bi-annual survey. The trade body group also warned that the proposed Financial Transactions Tax (FTT) could make matters even worse by further restricting the supply of scare collateral.

ICMA’s ERC data shows the total value of outstanding European repo contracts, under which banks pledge securities as collateral in return from funding from money market managers and other investors, stood at €5.611 trillion on 12 December 2012; indicating a 9.5% reduction in business since December 2011 when the figure was €6.2trn.

The ERC’s survey is based on returns received from 71 financial institutions (FIs) in Europe, and gauges the volume of repo trades outstanding on a single day. Analysis of a constant sample of survey respondents, using only the figures for the banks that participated in the last three surveys, indicates a 6.6% decline in market size since June 2012 and a drop of 11.9% year-on-year.

A statement issued by the ERC stated: “Continued weakness in the market is thought to reflect the effect of the European Central Bank’s [ECB] Long Term Refinancing Operations (LTRO) liquidity, which has meant that banks have been able to decrease their reliance on funding from repo operations in the market. However, the size of the market remains well above the trough recorded in the December 2008 survey [€4,633bn].”

Godfried De Vidts, ERC chairman, added: “The survey results demonstrate the continued existence of a robust European repo market. However the future of this market is in jeopardy. The European Commission’s latest proposal for an FTT comes at a time when the Basel Committee has guided interbank lending transactions away from an unsecured to a secured basis and when wholesale market participants, together with the central bank community, have moved to the repo market because it is the safest way of distributing liquidity throughout the European banking system.”

“The FTT proposals to tax repo transactions put the economic viability of repo, including tri-party, transactions at significant risk, which will lead to less liquidity provision to the real economy. [They] also put at risk the implementation of the European Market Infrastructure Regulation [EMIR], which requires the use of collateral for centralised and bilateral clearing.

“As the European Securities and Markets Authority [ESMA] highlighted upon release of its first EU securities markets risk report on 14 February: the collapse of unsecured markets during the financial crisis, as well as regulatory initiatives, have led market participants to rely increasingly on collateral as a means of mitigating counterparty risk, stimulating the demand for collateral. Additional demand for collateral will exceed the additional supply of collateral in 2013-2014, making collateral comparatively scarcer.

“If the FTT on repo transactions - which facilitate collateral being available where it is needed - goes ahead, the regulatory collateral crunch will actually materialise. Is that what we really want to happen?”