By Peter Altero Jr, Head of Rates Business Development at OSTTRA
Last month, ICMA sent a disconcerting letter to the European Central Bank (ECB) expressing widespread industry concerns about current conditions in the Eurozone repo markets, and the risk that rising dysfunction in the market could imperil the transmission of monetary policy. This letter from ICMA reinforces the pivotal tole that repo markets play in facilitating the flow of cash and securities around the financial system, with benefits to both financial and non-financial firms. Ultimately, a well-functioning repo market also supports liquidity in other markets, thus contributing to the efficient allocation of capital in the real economy.
The trouble is that, for too long now, inefficient repo workflows have long been an operational burden for market participants. Many of the middle and back-office systems and procedures were originally built off a highly voice driven market – without regulation. While the industry has done a good job applying a sticking plaster to allow them to comply with regulatory reporting mandates, things will become more challenging as mandatory clearing for certain security instruments looms large.
The misconception within the industry is investing in their own middle and back-office systems provide them a competitive advantage against their peers. The truth is it doesn’t. A portion of middle and back-office process are mandatory mundane tasks which command a lot of attention and can be potentially costly both from an investment standpoint and a profit and loss (P&L) issue if there is an error. Modernizing post-trade systems and migrating to industry wide networks creates the competitive edge firms are looking for, while freeing up staff to focus on more complex and time sensitive issues. At the core, the lack of centralization in the market is what drives a lot of the operational cost and risk within the repo market.
In the past few years, we’ve seen volumes hit record highs, in a time where new futuristic execution methods were introduced, and legacy execution methods, such as voice, are still thriving. This creates a requirement for new point to point data feeds and another point of failure for middle and back-office functions. But regardless of the pressure from the likes of ICMA, repo markets are still lightly regulated in comparison to other asset classes.
To overcome these longstanding inefficiencies, the industry as a whole must acknowledge that the current state in repo post trade is unsustainable. One only must look at other asset classes that have improved operational efficiency and resiliency – such as cash equities and FX. For repo, it will all be about the network and the industry envisioning the day when scalable services connect market participants, standardize data exchange, and facilitate communication for the key components of the repo lifecycle. This is possible, however, it requires the attention of support from key industry stakeholders.
There also needs to be a shift away from regional bifurcation. The industry needs a single post-trade solution which addresses all major centres where repos trade, regardless of the regional nuances. Putting functions like trade confirmation, portfolio reconciliation, and settlement on a central network removes complexity from the market. It also standardizes processes to reduce operational risk and mutualizes cost across the industry. If market participants stand any chance of complying with what is ahead of them, next year has to be a year of change. Let’s face it, a facelift for the post-trade repo space is long overdue.