The launch of the euro promised a much-heralded explosion in European repo markets and associated products. Pre-launch, repo players anticipated that the single currency would greatly boost euro repo transactions within the Euro-zone. Nearly two years later, we can draw some conclusions in assessing these predictions.
The use of the euro as a denomination currency in repo transactions has dramatically increased. This is, without doubt, the most significant impact of the euro on repo markets. Pre-January 1999, repo transactions in Emu-in currencies, which settled in the Euroclear System, increased (on average) by around 10% each year. Since the launch of the euro, the growth of euro repo trades has almost doubled to 18% per year. There is an apparent switch from US dollar repo deals to euro repo ones. Of course, the relative decrease in dollar repo deals is also be attributed to external factors, such as the Russian crisis and the relative weakness of emerging markets, but the emergence of the euro currency has been a real driver for the repo market.
In triparty repo, where transactions are purely cash-driven, we have noticed the same trend. Before January 1999, US dollar deals represented more than 50% of our entire triparty activity. Today, triparty repo deals denominated in euro amount to more than 65%, pushing dollars into the background.
Before the arrival of the euro, nearly all cross-border repo business was London-based. There are now clear signs that the market is more integrated and that the number of cross-border repo transactions between continental counterparties has increased. However, the emergence of cross-border repo transactions among euro-in countries is somewhat hindered by the lack of harmonisation between legal jurisdictions and tax regimes. Examples of this include the fact that repos are still not clearly defined in Spain and domestic repo contracts coexist with international ones.
With the support of the European Central Bank, a European repo agreement has been drafted. It supports cross-border repo transactions in the Euro-zone. However, this contract has not yet become a market standard. International players mainly use the general master repurchase agreement (GMRA), which is not limited to the Euro-zone. The GMRA has played an important role in the integration of the European repo market and is the most frequently used to support triparty repo transactions.
On a positive note, the launch of the euro has not only facilitated cross-border Euro-zone repo transactions, but has also attracted players from outside, mainly from the US. The size and liquidity of the euro market has convinced US cash investors and securities lenders to become active players in the euro. Directly from the US, they now easily manage a euro portfolio comprised of cash and securities. This US activity also somewhat explains the current success of the European triparty repo market. Indeed, the concept of triparty products is better developed in the US than it is in Europe. Moreover, these US players do not always have the back-office infrastructure required to support large volumes of activity in euro. Hence they look for an external provider, such as the Integrated Collateral Management platform.
On the security side, complete market integration is still more a dream than a reality. Cross-border activity is hindered by the lack of consolidation across European securities settlement platforms. Consequently, except for Bunds and Dutch government bonds, which are primarily settled in the Euroclear System, domestic government securities are still settled locally. This feature has a major impact on the European repo market as nearly all bilateral repo deals are still done in government securities. As a result, continental banks still concentrate the bulk of their repo activity locally, on their own domestic securities.
As mentioned, one solution to assist the European cross-border repo market would be increased consolidation of European settlement platforms.
Indeed, the Euroclear group is currently undergoing such a process. This was evidenced earlier this year when the Euroclear and Sicovam organisations announced the signing of a definitive merger and when the Irish government insourced the settlement activity for Irish government bonds in the Euroclear System. Additionally, our board and the boards of Brussels Exchanges (BXS) and Amsterdam Exchanges (AEX) announced the signing of a memorandum of understanding, which had as its ultimate objective the full merger of the Belgian and Dutch central securities depositaries, CIK and Necigef, respectively, into our group. The settlement systems supporting all three exchanges forming Euronext – ParisBourse, BXS and AEX – will thereby be consolidated as part of the Euroclear group. The needs of Euronext and market participants will thus be met at the lowest possible cost and with straight-through settlement efficiencies.
As stated, the bulk of bilateral repo deals is done on Dutch government bonds. For instance, in the Euroclear System, 50% of the turnover in Bunds is generated by repo transactions while only 7% of the turnover in Eurobonds is repo driven. Before the launch of the euro, market analysts predicted a large increase in repo deals done using corporate paper and more precisely, eurobonds. But the predicted emergence of the eurobond repo market has not yet occurred.
However, for one particular product there is an exception, namely triparty repo. Managing collateral in the name of the counterparties, a triparty service provider handles various administrative burdens, including pricing the securities. An integrated and fully automated collateral management platform is all the more compelling delivering higher levels of automation, sophisticated risk-management tools (eligibility criteria, concentration limits, and haircuts), and timely, efficient reporting.
This explains why more than 50% of the triparty repo outstanding handled in the Integrated Collateral Management platform (which has daily peaks of over E55bn outstanding) consists of eurobonds. From this perspective, these figures are quite encouraging for the European repo market, as, following the introduction of the euro, Euroclear triparty repo outstanding has increased by more than 20% on a yearly basis.
The euro repo market looks set to keep on growing. The only questionmark for the coming years is ‘at what pace’? The success of the euro will certainly depend on how key issues such as the harmonisation of legal jurisdictions and tax regimes, as well as the speed at which the settlement industry consolidates is addressed over coming months and years.
In the meantime, new trends will sustain market growth. On the security side, dealers are currently developing a European general collateral (GC) repo market. Being mainly cash driven, GC repo deals could naturally be handled through a triparty structure. On the dealer side, newcomers include corporate and fund institutions. The current liquidity of the European repo market offers them attractive opportunities. All told, it’s been a somewhat cautious start for the euro, but the potential of the single currency in terms of overall benefit to the market, is there for all to see.
Phillipe Verriest is a vice president at the Euroclear Operations Centre and a product manager for the Euroclear Integrated Collateral Management platform in Brussels