CSDR Buy-Ins May Kill Credit Repos

Shanny Basar

The International Capital Market Association has warned that the single biggest challenge to supply, and the health, of the credit repo market is the mandatory buy-in regime in new European Union regulation.

Andy Hill, senior director at ICMA, said in a report, The European Credit Repo Market: The cornerstone of corporate bond market liquidity, that the buy-in regime of Central Securities Depository Regulation, expected to be implemented in the European Union in late 2019, could destroy the corporate repo market.

CSDR, the regulation on central securities depositories and securities settlement, aims to make settlement more efficient by including the provision for penalties for settlement fails, when securities are not delivered, and a mechanism for executing mandatory buy-ins against failing transactions in financial securities. The regulation says buy-ins should be initiated in the event of a transaction failing for four business days, with the scope for this to be increased up to seven  business days. However, market participants argue that the risks of buy-ins, and the lack of protection sellers have with respect to failing repos, could increase pricing and make them less willing to provide liquidity.

Andy Hill, ICMA

“The overarching market view is that this will have dramatic and potentially devastating consequences for credit repo market liquidity,” Hill said. “Quite simply, it is the ultimate deterrent to lending corporate bonds.”

He continued that the health of the credit repos is critical to corporate bond market-makers who use the market to fund long positions and cover their short sales in order to make good delivery and support corporate bond secondary markets.

“The less depth and liquidity in the underlying repo market, the greater the risk of not being able to make good delivery on their sale, and so the greater the risk of being bought-in,” added the report. “The greater the risk of buy-ins, the less inclined holders are to lend their bonds. Which reduces repo market depth and liquidity. Which increases the risk of buy-ins.”

ICMA continued that buy-ins are currently relatively rare and manageable but the CSDR mandatory buy-in regime will significantly alter the risks and dynamics of both short selling and securities lending.

“In fact, of all the topics raised during the various interviews, none prompted such a palpable degree of resignation or despair as mandatory buy-ins,” added the report. “‘Total insanity’, was the response of one interviewee, a sentiment which seems to prevail in the responses of virtually everybody that was interviewed.”

The report did acknowledge the need for automating the highly manual and labour-intensive processes of the repo market in order to avoid decrease settlement failures. Although some automation exists, credit repo desks still largely ‘cut and paste’ interests and axe lists which they share with their various counterparties from a combination of internal reports, Excel spreadsheets and a Bloomberg terminal. In addition, the credit repo market, unlike the sovereign bond repo market, is not centrally cleared.

“On the face of it, this is a market screaming out for automation, yet it is not that straightforward, particularly given the range of underlying bonds being borrowed and loaned, the different means of transacting, the range of counterparties, different haircut matrices, bespoke schedules for collateralising borrows, as well as the importance of counterparty relationships and the need to call an occasional favour (particularly when things go wrong, such as a buy-in),” said ICMA.

In addition, automation is needed to meet the increased volumes of electronic trading of corporate bonds. The rise of electronic bond trading is demonstrated by the recent deals which look to aggregate liquidity in an increasingly fragmented market.

AxeTrading, which provides fixed income trading technology, announced a €2m ($2.25m) strategic investment from Illuminate Financial Management, a venture capital firm which focuses on capital markets financial technology. Last month Algomi, the bond information network, and fund manager AllianceBernstein announced a partnership to provide an aggregated picture of bond liquidity.

Mark Whitcroft, partner at Illuminate Financial Management, said in a statement: “With a strong and highly experienced leadership team, AxeTrading are well placed to solve key challenges for fixed income market participants today; liquidity fragmentation, regulatory compliance around MiFID II and the growing need to drive greater efficiencies across trading workflows.”

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