On Sept. 17, the rate on overnight Treasury-funded US repurchase agreements,1 or repos, jumped to an average of 5.25% from 2.43% the day before, with some trades settling as high as 9%. The move lifted the headline rate to more than twice its average in the previous year, an unusual spike in a relatively stable market.
Money markets, and in particular the secured lending segment, are the real cash lifeblood for companies, borrowers and dealers in bonds and derivatives. For central banks, money markets are one of the places where their monetary policy decisions get transmitted.
On the same day of the spike, the Federal Reserve Bank of New York intervened in the repo market, offering extra funding to ease a shortage.
While a review of the factors behind the rate spike and the roles played by banks and their supervisor continues,2 one positive conclusion emerges: the repo rate acted as an efficient alarm bell for the market. Without it, the New York Fed and investors would have been deprived of a real-time assessment of the ongoing funding pressure.
“The recent events in the US highlight the fact there is this number, and it does reveal information about market stress,” said Yuliyan Georgiev, Fixed Income Director at STOXX. “If you are interested in this information, and we would expect regulators and market participants to be, then the repo rate is the type of number that will give it to you.”
LIBOR manipulation leads to misinformation
This was not the case during the global financial crisis in 2008, when lending markets were still largely linked to interbank offered rates (IBORs) such as LIBOR and Euribor, benchmarks set by panel banks that were later found to have been manipulated. As the crisis rolled on and rattled markets, benchmarks like LIBOR — filtered and fudged to respond to banks’ interests — failed to accurately reflect the pain afflicting borrowers.
As central banks and regulators seek to replace long-established but flawed rates, the role of collateralized markets has gained relevance — mainly because they provide transparent information that objectively represents the dynamics and economics of the lending market. If seasonal or technical factors drive volatility up, a flag is promptly raised that allows market players and regulators to act accordingly.
European rates and ECB policy
In Europe, repo rates remained stable during the recent jolt across the Atlantic. There was, however, higher-than-normal trading volumes. The STOXX® GC Pooling EUR Deferred Funding Rate Volume Index jumped to the highest since 2016 on Sep. 17. This was three business days after the European Central Bank (ECB) announced it was pushing its key interest rate deeper into negative territory and unveiled a new plan to buy bonds to inject liquidity into the market. Repo volumes have dropped in recent years as the ECB flooded the financial system with cheap cash.
New money rates
Last month’s developments in the US won’t go unnoticed in the Eurozone, as critical money-market benchmarks are replaced. In September 2018, an ECB-sponsored working group recommended the euro short-term rate (€STR) as the risk-free rate (RFR) to replace the euro overnight index average (EONIA), whose use will be restricted by new regulation that kicks in from 2022
€STR, whose use is not mandatory, was first published on Oct. 2 this year. The rate reflects Eurozone banks’ borrowing costs in the wholesale unsecured overnight market, and it was one of three benchmarks considered by the ECB to replace EONIA.
A second one was STOXX® GC Pooling EUR Deferred Funding Rate, or GC Pooling Deferred, administered by STOXX. The rate represents general collateral (GC) transactions in euros captured on a liquid, centrally cleared and anonymous venue. The repo market is today home to a majority of lending transactions and its characteristics make it particularly valuable during periods of stress, when a viable and unbiased RFR is needed.
Secured-lending rates have their advantages, as proven by last month’s move. They serve a purpose, just as the underlying repo market suits lenders and borrowers in specific ways. Collateralized transactions will continue to be a key funding source running in parallel to the unsecured lending markets. The use of secured rates as RFRs, independent of and in co-existence with unsecured rates, can only enhance the transparency and functioning of the financial system.
