How peer-to-peer lending can address market needs in repo

June 7, 2024

Key Takeaways

  • Repo has bounced back on higher rates and tighter monetary policy
  • P2P is an effective way to access liquidity and diversify risk
  • It should be an integral part of a firm’s wider tech ecosystem

After a prolonged period of negative interest rates, repurchase agreements (repos) have made a strong comeback as volatility spiked and liquidity drained. However, unlike equities, government bonds, and even corporate bonds, the repo market has historically been thought of slow to embrace new technologies, such as peer-to-peer (P2P) platforms. A lack of standardization, reliance on intermediaries, and post-trade complexities have hampered progress, but change is in the air.

Repos provide short-term funding where sellers offer assets, typically fixed income securities, as collateral to another party at an agreed price, while committing to repurchase the same asset at a different price in the future.

The Securities Financing Transaction Regulation (SFTR) has been in place since 2020 and today more than 140,000 repo trades with a notional value of over EUR 4 trillion are reported every day in the EU and UK, according to the London Reporting House.

Changing macro dynamics

Repo’s resurgence can be attributed to a confluence of factors, including higher interest rates, tighter monetary policy as well as the protective layer they offer against credit and liquidity risk. In fact, in its annual wrap-up, Eurex noted that the paradigm shift in monetary policies of central banks affected liquidity and contributed to a revitalization of the repo cash funding markets in 2023.

The German exchange highlighted the sudden rise in interest rates and accelerated repayments for the Targeted Longer-Term Refinancing Operations (TLTRO). The consecutive hiking regime in the region to curb stubborn inflation – 400 basis points from June 2022 to December 2023 – reduced excess liquidity from record highs in 2022 of around EUR 4.7 trillion to EUR 3.5 trillion last year.

It also noted that the onslaught of regulations coming will have an impact on the repo market. This includes Basel 3, EMIR 3.0 and the recent mandate set out by the US Securities and Exchange Commission to centrally clear transactions in the US Treasury cash and repo market. The new rules come into effect from March 2025 for clearing houses and June 2026 for repo transactions.

P2P comes to the fore

Given the changing landscape, cost, liquidity, and counterparty diversification will continue to be paramount, which is why it is time for buy-side firms to take a closer look at P2P platforms. While they are not a new concept, the latest offerings on the market are improved and can tackle today’s challenges, according to a State Street thought leadership paper.

One of the main advantages is that the intermediary is removed from the picture and buy-side firms can trade directly with one another, while a bank provides indemnification to supply credit intermediation. This eliminates the traditional spread taken by dealers to offer potentially improved rates and unlocks new pockets of liquidity. These products also offer flexible execution and post-trade tools with near real-time processing, creating an efficient repo trading process from initiation to settlement within a single provider’s network.

Although the benefits of P2Ps may be universal, this is especially true in EMEA, where liquidity is bifurcated across several markets and currencies. In addition, there is a high number of specials in the region driven by an excess of demand for a particular issue of securities over its supply. Using P2P can help address these collateral scarcity problems by creating an additional opportunity for market participants to access balance sheets and assets that were traditionally off-limits.

P2P is also seen as opening the door for a wider group of participants. Traditionally, repo has been limited to dealers and brokers who had the resources (e.g. balance sheet) and deep pockets (e.g. to support the complex technology required) to be the go between borrowers and lenders. This made it difficult for smaller and medium-sized firms to get their foot in the door. They not only struggled with the stringent entry requirements but also the collateral demands imposed. The inability to find additional liquidity impeded their ability to grow and develop a competitive edge. By contrast, P2P gives them inroads into new liquidity channels as well as cost-effective financing costs across a range of collateral types.

However, these platforms should not be considered in isolation. They are only one, albeit important, piece of the equation and should be seen as an integral part of the technology infrastructure alongside other automated platforms, electronic trading systems, and pre- and post-trade processes. The aim should be an end-to-end ecosystem where all the components fit seamlessly together.

ION Markets

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