Now Repo Distortions Are Emerging in Europe’s $9 Trillion Market

BIS finds euro repo market is functional but more fragmented. Segmentation could impede redistribution of liquidity, it says.

By Anchalee Worrachate and cross-posted from Bloomberg.

The European repo market may have escaped the kind of turmoil that engulfed the U.S. financial system this year, but that doesn’t mean all is calm.

The 8 trillion-euro ($9 trillion) market is becoming increasingly fragmented, according to the Bank for International Settlements. While this hasn’t caused harm yet, it raises the risk that cash may not flow through the system properly, BIS said in its quarterly review. That’s what caused chaos in the U.S. almost three months ago.

Trading repos — repurchase agreements where bonds are used as collateral for short-term loans — acts as the essential plumbing for the wider fixed-income market. The Federal Reserve was forced to take action to calm the U.S. repo market after rates spiked in mid-September. Some fear a similar event later this month, when year-end liquidity needs renew the pressure.

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The BIS report showed trading of specific collateral rising compared with activity for general collateral, which is used for funding.

The BIS study found the European repo market has in recent years been driven by investors seeking specific collateral rather than funding. That exacerbates a segmentation along collateral lines, where liquidity, price and behavior of securities all vary by geography and some traders specialize in bonds issued by their own government.

The whole trend has gained strength thanks to central bank stimulus, which simultaneously increased funding liquidity but removed collateral, the BIS said.

“This may impede the redistribution of liquidity,” authors Patrick Schaffner, Angelo Ranaldo and Kostas Tsatsaronis wrote in the report

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