11 September 2013


Regulations aimed at preventing another financial meltdown are beginning to pose problems for the Repo market and by extension the bond market internationally, particularly the United States and Europe. 

Repurchase Agreements or “Repos” are money market instruments, used to help finance investments in Treasuries, corporate bonds and mortgage backed securities.[1]  For example, a fund manager i.e. pension plan, credit union or Insurance company may lend cash to a dealer for a period of time primarily, with government securities serving as the collateral for the loan. Dealers use repos to boost leverage and amplify returns, while the fund managers or lenders earn interest on the cash they provide.

The repo markets are really the grease in many financial markets according to Josh Galper, the Managing Principal of Securities – Finance Consultant Finadium LLC. His view is that increased friction in fixed income markets such as decreased repos will result in less liquidity in bond markets, higher costs to borrow, more volatility and less security.

“The Rule”

The new “rule” that is potentially destabilising to financial markets is that banks are required to hold a certain level of extra capital against ALL of their assets. This is meant to cap the financial industry’s borrowing levels in a simpler blunter way. This new proposal goes beyond the current BASLE ratios to measure equity to total assets, rather than formulas that let banks hold less capital for assets deemed less risky like treasuries.[2]

 “The Impact”

This new rule, although just proposed, has already started to affect dealers;

  • Banks are reducing their Repo positions to present more attractive balance sheets. The U.S. repo market shrunk to $4.6 billion, marking a thirty five percent (35%) decline from a peak of $7.02 billion in the first quarter of 2008.
  • In Europe, the biggest banks must cut 661 billion euros ($883 billion) of assets and generate 47 billion euros of capital to comply with this new regulatory capital requirement.
  • Regulatory changes will cause dealers to reduce risk and to make markets less aggressive. End users will lose some liquidity as dealers adjust to higher risk capital mandates, lower leverage limits and increased margin requirements.
  • The higher capital requirements have already affected banks’ ability to hold corporate bonds. Big banks’ inventories of corporate bonds have sunk from a 2007 peak of $235bn to $54bn mainly due to the new regulation.[3]

Although the concerns of the bond market are that it is less efficient with fewer repos, some feel that some major players in the market are over-reacting.  David Glocke, a portfolio manager at Vanguard, is of the view that “from a liquidity standpoint, the depth and breadth of the market is just as deep as it has ever been and the people /institutions that are affected are doing their best to ensure the regulators are aware of their concerns”.

This new leverage “rule” is going to hit the repo business, securities lending and government bonds plus any derivatives that may be associated. Market players have already begun warning that some aspects of the rule can affect the wider economy; for example, limiting “unfunded credit commitments” which they offer to customers.[4]

Although the article focused on the United States and Europe, this will affect our local financial sector, i.e. commercial banks and non-bank financial institutions. The Central Bank of Trinidad and Tobago is adopting similar/ amended legislation to the Basel Accord to ensure that the banks maintain a certain minimum of 10% of equity to match their assets.

Each asset within the Institution’s portfolio will be assigned a risk weighting in proportion to equity. With that said, we may see in time that local commercial banks and non-bank financial institutions  limit the amount of Repo investments on their Balance Sheet to stay within their capital requirement, mainly because Repo investments have a risk weighting of 100%.

How would this new regulation affect our already inactive bond market? Furthermore, how will this affect Securities companies like ours that rely heavily on “repos” as a source of funding?

We may just have an answer or two already up our sleeve. Why not call us today on 1-868-628-1175 or email us at info@nullfirstlinesecurities.com.

Natalie Crawford


[1] Bloomberg news-Repo market decline raises alarm as legislation strains Debt- Aug 19-2013.

[2] Financial Times- New Rule threaten repo market- August 19-2013

[3] Bloomberg news-Repo market decline raises alarm as legislation strains Debt- Aug 19-2013

[4] Financial Times- New Rule threaten repo market- August 19-2013

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