The current state of Europe’s market in repurchase agreements, aka repos – short-term borrowing for dealers in government securities – is assessed in a newly-published report issued by credit ratings agency (CRA) Fitch.
Key points from the report are as follows:
- Repos declining in European Union MMFs: Repurchase agreement exposures in European triple A-rated prime money market funds (MMFs) declined to 4.2% in September 2016 from 6.7% two years earlier. The overall offshore European prime MMF universe, representing around €490bn of assets, has comparable exposure to repos.
Fitch adds that MMF repo investments are only a fraction of the overall EU repo market: the total repo amount outstanding in Europe was €5.4 trillion in June 2016 according to the International Capital Market Association (ICMA), marginally down from the year before.
- Repo seasonality: Temporary declines in repo use at month-end, quarter-end and year-end are linked in part to the absence of high-quality paper available used as collateral, and banks’ regulatory reporting requirements.
- Repos in common use: Around 63% of Fitch-rated MMFs were undertaking repo transactions in September 2016, against about 54% two years earlier, despite the decline in exposures. All MMFs are eligible to engage in repo transactions; however about 85% of those rated by Fitch have set up the legal documentation with counterparties in order to be able to engage in repo transactions.
- Liquidity management tool: Repo transactions in European MMFs are mainly used for portfolio liquidity management as they have short maturities, between overnight and seven days, or longer but with up to 48-hour call options. UCITS (Undertakings for Collective Investment in Transferable Securities) funds in particular are required by regulation to limit repo investment maturities to seven days (or callable within seven days).
- Operational drawbacks: As setting up a repo transaction can be operationally complex, 70% of repo transactions are conducted in tri-party form where the custodian handles the operational side.
- Counterparties are mostly French or US banks: The number of repo counterparties has not significantly changed over the past two years. US and French banks are the most widely used repo counterparties in European-domiciled prime MMFs.
- High-quality government collateral dominates: Repo collateral in European MMFs comprises high-quality US and European governments and their agencies. There is typically no maturity restriction on collateral and EU prime MMFs typically require the standard 102% over collateralisation. However, some funds may exercise different overall levels, according to collateral security type risk profile.