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The study builds on ICMA’s previous work with respect to both corporate bond market and repo market evolution and liquidity, and investigates the European credit repo market from the perspective of its role, structure, participants, dynamics, external impacts, challenges, opportunities, and potential evolution, particularly to the extent that this plays a pivotal role in overall corporate bond market liquidity.
The European credit repo market appears to work well, however, the capacity for the market to function effectively is highly dependent on the supply of corporate bonds into the market. The extent to which buy-side holders are able and willing to lend their holdings back into the market, whether directly or through agent lenders, has a direct bearing on the ability and willingness of banks to support the market-making function that underpins bond market liquidity. For the most part, supply into the European credit repo market is relatively good, particularly with respect to investment grade corporates. And while repo rates for specials, particularly in the high yield space, can be expensive and volatile, there is usually still availability.
The changing nature of the underlying market, with a trend toward smaller trade sizes and more rapid turn-over of dealer positions, is making sourcing supply more difficult. While there may be plenty of bonds in the lending programmes, there is little or no economic incentive to lend small sizes for very short-periods.
Looking forward, the single biggest challenge to supply, and so the health of the credit repo market, is the CSDR mandatory buy-in regime. The overarching market view is that this will have dramatic and potentially devastating consequences for credit repo market liquidity. Quite simply, it is the ultimate deterrent to lending corporate bonds.
While any increase in the cost of capital to support credit repo intermediation has an impact on corporate bond market pricing, the biggest challenge to credit repo intermediation is likely to come from the application of NSFR, which will increase the cost of borrowing corporate bonds significantly. The additional costs of NSFR on credit repo intermediation will need to be passed on to dealers and clients through the repo rates charged, and so ultimately into the pricing of the underlying market. However, there is also a risk that the additional costs of NSFR may result in the reduction in or withdrawal of credit repo desks’ services beyond financing their own trading desks.
While ongoing and future challenges to supply and intermediation will ultimately determine the credit repo market’s ability to play its pivotal role in supporting corporate bond market liquidity, there would certainly seem to be scope for creating efficiencies through automating many of the highly manual and labour-intensive processes of the market. However, automating the credit repo market is not straightforward, given the intricacies and nuances of the market, with the market becoming even more complex and fragmented with every new layer of regulation.