How has the changing cash-collateral backdrop affected repo markets?

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Repo rates globally have ticked higher over recent years, and since September 2023 sterling repo rates have consistently traded at a positive spread to Bank Rate. This largely reflects the evolving landscape in which reserves balances are falling and the available stock of government bond collateral is growing.

Why do repo markets matter?

Repo markets are vital in facilitating the flow of cash and securities around the financial system.[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)

Since February 2022, the stock of aggregate reserves has decreased by around £250 billion while UK government bond free-float has increased by around £500 billion.

As a result of the shifting cash-collateral balance in the system, there has been upward pressure in repo rates globally (Chart 2).

Chart 2: The spread of overnight repo rates relative to respective policy rates (a) (b) (c)

There has been upward pressure in repo rates over the same period.

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.[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)

General collateral rates in the different environments of pre and post dash for cash, collateral scarcity and plentiful collateral. The rates relative to the Bank Rate have settled over time.

Chart 4: Overnight specifics repo rates by collateral maturity bucket since July 2016 (a)

A more plentiful collateral environment has resulted in a reduction in the spread between secured borrowing rates on specific bonds and the general collateral rate.

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.[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.

Chart 5: Overnight GC repo rate versus STR drawings (a) (b)

Uptake of the Bank’s Short-Term Repo facility has grown to £46.7 billion in October 2024.

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.

Chart 6: Gross repo and reverse repo outstanding stocks by tenor (a) (b)

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.

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.[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.

Chart 7: Overnight GC repo rates and average overnight volumes over previous year-ends and 2024 quarter-ends (a) (b)

Sterling overnight repo rates have spiked upwards at period ends as dealers seek to place plentiful collateral and borrow cash.

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 netting[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.

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