The Reform of European Repo Markets

Regulators at the FSB, IMF, the ECB and the European Commission define the repo market as a systemic shadow market in need of urgent reform. The repo market has become central to global (shadow) banking because risk practices support cross-border financial relationships that are more remote and complex. Rather than a shadow market energized by regulatory arbitrage, the European repo market grew out of a public-private joint venture before the crisis. The repo market is distinctive in that it ties a wholesale money market to distinctive collateral markets (including government bond markets), securities and derivative trading, operating as the nervous system of market-based finance. This very distinctiveness put it at the heart of a European repo bargain before the crisis. Governments and European institutions sought to use repo markets as an engine for rapid financial integration, more effective monetary policy and higher liquidity in asset markets, including government bonds markets. In turn, global banks, headquartered in Europe and elsewhere, relied on repo activities to fund rapid balance sheet growth through market-based activities. The paper argues that the crisis destabilized this repo bargain on the terrain of the Financial Transactions Tax until the ECB stepped in to dissuade governments from taxing repos, sidelining crucial questions about the systemic vulnerabilities created through European banks’ repo activities and the role of European governments as main manufacturers of repo collateral. This raises broader questions about the role of the ECB in designing and managing the Capital Markets Union envisaged by the new European Commission.