February 14, 2017 / 12:03 PM / 10 months ago

European repo funding market crunch could be "new normal" -ICMA

LONDON, Feb 14 (Reuters) - Problems banks and big businesses encountered raising short-term funding in Europe at the end of last year could become “a new normal” and pose a systemic risk to the functioning of markets, trade association ICMA said on Tuesday.

A bond drought partly caused by the European Central Bank’s quantitative easing scheme created in late December a crunch in repurchase agreements, or repo, which firms use to raise cash against collateral.

“The extreme volatility and market dislocation experienced in the euro repo market over the 2016 year-end are unprecedented in the post-euro era,” the International Capital Market Association (ICMA) said.

“This has raised concerns over whether this was a one-off event, or rather this is an indication of a market that no longer functions efficiently and effectively under stressed conditions, and signals a new normal for the European short-term funding and collateral markets.”

ICMA, which has raised its concerns with European authorities, said the problems were caused by a combination of the ECB’s asset purchase scheme - scheduled to run until at least the end of 2017 - and regulation that limits banks’ balance sheets and ability to intermediate in repo markets.

The ECB introduced a bond-for-cash scheme in December to try and alleviate stress in repo markets, but the effectiveness of that programme has been called into question by the recent squeeze.

Godfried de Vidts, chairman of ICMA’s European Repo and Collateral Council, said not addressing the problems could have dire consequences for the functioning of markets.

“If some of the participants, even a medium-sized bank, cannot fulfil their obligations, in principle that clearing house should close out that bank because they are in default. That could create a snowball effect,” said de Vidts.

“A two- to three-day pressure like we have seen should not be repeated because it really could expose the market to dangers that we don’t really want to think about because it would stop the system functioning.” (Reporting by John Geddie; editing by John Stonestreet)

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