At long last, an opportunity for repo markets to benefit from change
While a clear vision of the benefits which automation can bring to the capital markets has been spreading for several years, global repo markets doggedly have been stuck in their old ways. Despite much prompting and the vast potential cost and risk-effective transformation, this $12 trillion ecosystem is one of the last major markets to adopt and deploy integrated electronic infrastructure. There are signs, however, that this is changing as awareness of and confidence in new competitive electronic solutions builds.
Repos and reverse-repos are at the core of the financial markets’ plumbing. They underpin government, agency and corporate bond trading, provide a critical source of short-term funding, enable smooth management of liquidity and collateral, and help accelerate trade settlement and margining. In order to continue to provide this vital cohesiveness, to become increasingly cost and capital-efficient and to meet upcoming regulatory demands, repo markets will need to rely increasingly on technology.
In the heart of the Financial Crisis, as markets seized, lack of visibility into repo markets accentuated market turmoil as trust evaporated and participants became concerned about counterparty reliability – most dramatically Lehman and Bear Stearns – and their ability to repay loans. Though far from the only precipitant of volatility during that period, absence of visibility into short-term financing markets magnified reluctance to roll over loans, prompting liquidity to dry up and consequently some businesses to crash. Today, despite some measure of regulatory overhaul, certain of these repo market risks remain unresolved.
Basel III, and in particular the introduction of the Liquidity Coverage Ratio (LCR), have made it more expensive for large bank dealers to run repo books, consequently causing significant pressure on net balance sheets available for repo and securities lending activities, according to various studies by major banks, regulators and market analysts. The core of this pressure has been the challenges associated with balancing capital allocations and counterparty risks against the relatively small nominal margins generated by these activities. New proposals by regulators have only served to accelerate this cost pressure.
The most compelling solution to these pressures is newly evolving technology that can make existing, crucial dealer-to-client flows more efficient and data-rich, while less prone to error. Success in these efforts will improve economic returns in this business line, afford a clearer view of risk exposures and hold the promise of enhanced decision-making related to both liquidity and collateral management.
Repo is a market primed for reaping the benefits of technology in an era of heightened regulatory scrutiny and a rapidly evolving market landscape. However, one longstanding challenge to tech adoption has been that the complexity of the repo market – its persistent credit intensity, highly constrained ability to fractionalize exposures, multi-variable negotiation, so-called “midlife events” of repricing/re-rating/substituting collateral, just to name a few – does not lend itself as easily to automation as many other financial marketplaces. Successfully overcoming these challenges requires the highly flexible, rapidly developed and interconnected, customizable capabilities of the most modern technology – characteristics well beyond the reach of decades-old legacy systems currently in use by numerous major technology providers.
As has been the case with fixed income trading in general, the repo market has been late to the technology party. Given the mission-critical nature of the short-term financing markets, buy-side institutions have rightly valued their personal Fixed Income sell-side relationships and much of the reluctance to transition to a new age of “Fintech solutions” has been intended to preserve these contacts and working practices. The beauty of the newest technology solutions for these markets is that participants can have both efficiency and strong relationships. The newest digital architectures are able to enhance buy-side to sell-side relationships and practices rather than changing their essential and longstanding value. By helping to improve cost, capital and execution efficiency while minimizing errors, more time can be spent in productive, market-focused buy/sell side engagement. When combined with the ease of access of these new technologies, a compelling mix of “positives” for their adoption has arrived.
A Journey of a Thousand Miles
While the value of more efficient execution and access to higher-quality data is difficult to dispute, many remain wary of onerous on-boarding processes, high implementation turnaround times and costs.
However, just as the accessibility of consumer technologies such as smartphones and streaming content has dramatically improved in recent years, prompting widespread adoption, similarly intuitive and indispensable technologies are today on the doorstep of the repo market. These architectures allow market participants to enjoy the enormous benefits of technology with literally no disruption, affording the ability to onboard immediately while integrating to the extent and in a timeframe of their choosing, consistent with their business flow.
Finally, given shear size and intrinsic value to global financial markets of the repo and broader securities financing markets, it would be overly optimistic to expect the embrace these new technological capabilities overnight. However, progress in many other major Fixed Income markets combined with the enormous advantages of modern and currently available architecture brings into focus the potential for repo markets -complete with its complex flow – to move into the modern age of technology starting now.