Why do repo markets matter?
Repo markets are vital in facilitating the flow of cash and securities around the financial system.footnote [1] A repurchase agreement (repo) involves one party lending cash to another party, secured against some form of collateral. As well as a source of short-term funding, repos can also be used to source bond collateral for speculation and risk management activities.
This post focuses on gilt repo – sterling repo backed by UK government bonds – where the vast majority of transactions rely on dealer intermediation. The gilt repo market plays an important role in supporting the functioning of the gilt market, by facilitating short-term liquidity and collateral management. Central banks also use repo-like facilities to supply reserves (deposits held by commercial banks at the central bank) and ensure interest rate control.
How has the changing cash-collateral balance affected repo markets?
Globally, reserves have fallen and bond issuance has increased over the past few years, changing the cash-collateral balance in repo markets. In the UK, since February 2022, the stock of aggregate reserves has decreased by around £250 billion. Reserves have fallen globally as many advanced economies have engaged in quantitative tightening (QT), and in the UK the unwind of the Term Funding Scheme with additional incentives for Small and Medium-sized Enterprises (TFSME) has also contributed to the decline in reserves. During the same period, UK government bond free-float has increased by around £500 billion, through a combination of higher net issuance and QT sales. Money markets have therefore shifted from an environment of relatively plentiful reserves and collateral scarcity towards the present period of declining (though still abundant) reserves supply and more plentiful collateral (Chart 1).
Chart 1: Ratio of sterling reserves balances relative to gilt free-float (a)
Footnotes
- Sources: Bank of England data, UK Debt Management Office and Bank calculations.
- (a) The gilt free-float is calculated using gilt issuance history as the total amount of gilts outstanding in nominal terms (not including the index-linked uplift) less the Bank of England’s holdings of gilts – including both temporary holdings related to financial stability intervention and Asset Purchase Facility holdings.
As a result of the shifting cash-collateral balance in the system, there has been upward pressure in repo rates globally (Chart 2).
Footnotes
- Sources: Bank of England, Bloomberg L.P. Finance, European Central Bank (ECB), Federal Reserve, Sterling Money Market Data Collection and Bank calculations.
- (a) This chart looks at the spread between broad overnight general collateral repo rates and policy rates for each jurisdiction. For the UK, the repo rate is calculated using the Sterling Money Market Data Collection and the policy rate as Bank Rate. For the US, SOFR is used as a repo rate and IORB as the policy rate. Lastly, the repo rate for the euro areas (EA) is taken from a STOXX pooled index and the policy rate considers the ECB Deposit Facility Announcement Rate.
- (b) It excludes quarter-end reporting dates and any data points that display a spike attributed to a monetary policy decision (removed at best endeavour).
- (c) Each series computes a five-day rolling average.
For the UK, the Bank’s Sterling Money Market Dataset (SMMD) allows us to differentiate between gilt repo trades that are driven by the demand and supply of cash, where agents are indifferent around the specific collateral used (ie general collateral (GC) trades), and those that are collateral-driven, where specific collateral is pledged.footnote [2] In the current plentiful collateral environment, the spread of GC rates relative to Bank Rate (GC-BR spread) has settled at a positive spread to Bank Rate. This is above average rates observed in the post dash for cash and collateral scarcity regimes (Chart 3). In collateral-driven rates, the return to a more plentiful collateral environment has resulted in a reduction in the spread between secured borrowing rates on specific bonds and the GC rate (Chart 4). This ‘specialness’ was particularly acute for short-dated collateral bonds since the start of the tightening cycle.
Chart 3: Histogram of the overnight GC rate as a spread to Bank Rate under different regimes (a) (b) (c)
Footnotes
- Sources: Sterling Money Market Data Collection and Bank calculations.
- (a) Pre dash for cash: a period most comparable to present, albeit capturing the adjustment to the implementation of Basel 3. Post dash for cash: peak reserves in the system, which applied downward pressure on rates. Collateral scarcity: a period of reduced collateral availability. Plentiful collateral: there is currently greater collateral availability and less cash as the Bank transitions to a demand-driven reserves system.
- (b) The date used for the dash for cash is 9 March 2020.
- (c) The dashed grey line shows the average for each period.
Chart 4: Overnight specifics repo rates by collateral maturity bucket since July 2016 (a)
Footnotes
- Sources: Sterling Money Market Data Collection and Bank calculations.
- (a) The downward spike observed towards the end of 2022 depicts where the period of collateral scarcity was at its peak and amidst the liability-driven investment episode. These pressures eased as the availability of collateral improved across 2023.
Alongside the increasing GC rates in the gilt repo market, uptake of the Bank’s Short-Term Repo (STR) facility has grown and reached £46.7 billion in October 2024 (Chart 5), with a broad range of counterparties using it, as intended. This is consistent with the facility’s intended purpose of ensuring interest rate control as the Monetary Policy Committee unwinds its asset purchases.footnote [3] The STR, in parallel with the longer-term Indexed Long-Term Repo (ILTR) facility, will supply the stock of reserves that deliver on the Bank’s vision of a demand-driven operating framework in steady state.
Nonetheless, STR usage continues to make up a small proportion of equivalent and total repo market activity. Total repo and reverse repo volumes and stocks have risen consistently year to date, with levels consistent with those observed around the start of 2022 (Chart 6).
While the shifting cash-collateral balance has globally impacted rates in repo markets, it has not changed the core functioning of these markets and the repo market has been functioning well.
What do period-end spikes tell us about the cash-collateral balance?
Repo market functioning is reliant on dealer intermediation for the provision of liquidity as do a number of core markets.footnote [4] This reliance manifests itself in period-end repo rate spikes, in which the direction of the spike is in part dictated by the cash-collateral backdrop.
It has been a consistent trend in global repo markets that repo rates can temporarily spike either upwards or downwards at month, quarter and year-end. During these period ends, dealers are incentivised to either charge more or step back from intermediating repo trades. This is largely due to balance sheet constraints, where dealers consider the regulatory and other costs associated with their balance sheet size over these periods. Banks also borrow and lend where rates appear most attractive, meaning some firms may have flexibility to reduce repo involvement and turn to FX swap markets as banks seek to allocate capital most efficiently. The FX-OIS basis can mean that it is more cost effective to transact in foreign money markets and change the proceeds back to the domestic currency – incurring a lower all-in cost than engaging solely in the domestic currency. This can lead to elevated daily volumes in GBP/USD FX swaps, above the average levels, ahead of key reporting dates.
In the UK, the direction of the repo rate spike depends on the balance of cash versus collateral demand and supply in the market, with period-ends exacerbating the dynamics of the gilt repo market at the time which, in turn, dictate dealers’ incentives. In the past year, sterling overnight repo rates have spiked upwards at period ends as dealers seek to place plentiful collateral and borrow cash (Chart 7). Previously, when the cash-collateral balance was the opposite, dealers wanted to borrow collateral and place cash, inducing downward spikes.
The past two year-ends have been out of line with history, with a limited spike observed in repo rates. Given the moves we have seen over quarter-ends globally over 2024, we may see a more prominent move in global repo rates at year-end which may result in an overnight GC-BR spread greater than that observed at the last quarter-end (17 basis points GC-BR spread in September 2024). This is consistent with current pricing implied by forward-starting repo rates across several jurisdictions, with elevated overnight repo rates anticipated by market participants over the year-end turn. These repo rate spikes do not indicate structural cash scarcity, are historically temporary, and don’t tend to spill over into unsecured rates. Market participants prepare ahead of time by ‘terming-out’ their funding and collateral to avoid having to trade over this period and be subject to spikes in the repo rate. During this period, there may be less of an incentive for participants to use the STR to source funding, as firms may seek alternative sources that allow for balance sheet nettingfootnote [5] or use internal channels to deploy collateral which may be temporarily more attractive. Once these temporary effects unwind we expect to continue to see the STR operating as intended.
This post was prepared with the help of Olga Turko and Callum Ashworth.
This article is based on material presented to Governors in 2024 Q4.
Share your thoughts with us at BankOverground@bankofengland.co.uk
Please see Sterling money markets: beneath the surface for more detail on the different types of repo rates.
See the STR Explanatory Note for further detail.
The Financial Policy Committee has previously noted the risks posed by disruptions to dealers’ ability to intermediate in gilt repo markets (see October 2023 Financial Stability in Focus, July 2021 Financial Stability Report, and December 2019 Financial Stability Report).
Dealer's repo (or reverse repo) transactions are ‘nettable’ if their value can be offsetted against reverse repo (or repo) transactions with the same counterparty and maturity, such that only the net amount is recorded as a balance sheet exposure.
