Jan 14 (The following statement was released by the rating agency)
Developments in US Federal Reserve tapering and
financial regulation will weigh on the US tri-party repo market again in 2014,
Fitch Ratings says. The US tri-party repo market dropped USD257bn or 14% in
2013, largely as interest rate rises and regulation influenced volumes. Much
will depend on how interest rates move and how banks adjust to the Basel III
leverage ratio finalised on Sunday.
The US tri-party repo market as a whole declined to USD1.61trn at end-2013
according to Federal Reserve Bank of New York data published last week. Agency
MBS repo and to a lesser extent, Treasury, were the drivers of the fall. Agency
MBS repo fell by USD226bn or 28%, while Treasury repo fell 10%.
The interest rate sensitivity of the collateral means agency MBS and Treasury
repos were more affected as rates started to rise in May 2013 on the expectation
of tapering of quantitative easing. Valuation losses, amplified by the use of
leverage in repos, and resulting market volatility are likely to have
contributed to lower volumes. Agency MBS repo supply could also have been
affected by the precipitous drop in mortgage refinancing following the rate
pick-up, which adversely affected mortgage origination across the industry. The
interest rate environment will remain a source of uncertainty in 2014 affecting
incentives for repo market participants and the supply of repo collateral.
Tougher financial market regulations and deleveraging in the financial sector as
institutions adjust to Basel III rules being phased in from 2014, have also hit
US tri-party repo volumes. Regulatory constraints on banks' trading activities,
including the Volcker Rule and more conservative Basel 2.5 market-risk capital
charges, may reduce their repo funding needs and their repo intermediation
The Basel Committee's recently-proposed recognition of limited bilateral netting
within the leverage ratio could ease some of the regulatory capital pressures on
banks that participate actively in the repo market. However, the impact on repo
depends on how these changes are implemented. Minimum leverage ratio standards
have yet to be finalised by national regulators and could therefore vary across
jurisdiction. At the same time, systemic risk regulators have been focused on
curbing potential "fire sale" risks, in which repo funding disruptions could
have cascading effects across financial markets more broadly. This policy
uncertainty could shift the competitive landscape for repo activities. Volumes
could also migrate to the shadow banking sector and financial institutions not
subject to these rules.
In 2013 the decline in agency MBS and Treasury repo has been partially offset by
moderate increases in equity, structured finance, and corporate repo collateral.
These lower quality forms of collateral increased by 18% or USD45bn in
aggregate, as these products make up a smaller part of the overall tri-party
market. Repo lenders may have been attracted by higher yields on these products
compared to MBS and Treasury because of the continuing low-yield environment.
For more details on the U.S. tri-party repo market see our report "Repos: Market
Decline Amid Policy Risk" published 20 December 2013.