Turmoil In The Banking Industry Boosts A Hot New Market For Funding

As a result of the financial pressures on balance sheets, the use of sponsored repo is on the rise.

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There has been a surge in trading volumes in one of the hot corners of the funding market, which has never been higher since the pandemic started.

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The so-called sponsored repo transactions are a means for lenders to engage in financing transactions with counterparties like money-market funds and hedge funds with a minimal impact on their own balance sheets, as they do not have to deal with regulatory constraints. The bank is effectively 'sponsoring' these reverse repurchase agreements through the Fixed Income Clearing Corp.'s repo platform in order to enable the dealer to get both sides of a repo trade while retaining less capital against said trade.

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A recent report from Barclays Plc strategist Joseph Abate shows that sponsored repo volumes have reached around $400 billion, roughly doubled from the previous year, even before Silicon Valley Bank collapsed last month. However, the following turmoil is thought to have helped boost volumes to around $400 billion, according to Trade Algo’s research. 

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Abate wrote in a research note that "sponsored repo volumes are now higher than they were in early 2020." A lot of the increase in activity is likely to be caused by the positioning of the balance sheet in advance of the quarter's end. Sponsored repo is a tool that dealers use to reduce the consumption of their balance sheet by multilaterally netting on reporting days, but it is also likely that money funds are increasing their demand for sponsored repo."

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As the vast repo market is often described as the plumbing of the US financial system, clearing is intended to help decrease the risk associated with trading trades in this market. Sponsored repo usage has also come under scrutiny for encouraging financial players to move into short-term, overnight funding markets that might suffer a volatile pullback if a market shock occurs.

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In part due to “increasing balance sheet pressures” in the banking system, sponsored repo volumes have soared since October, according to Lou Crandall at Wrightson ICAP. It is possible that leverage ratio constraints created stronger incentives to steer repo activity to sponsored clearing since large globally systemically-important lenders "have experienced unplanned balance sheet growth since SVB collapsed due to deposit inflows".

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Sponsored repo volumes are expected to remain elevated in April, suggesting the banking system faces continued challenges.

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The surge in repo volumes at the end of March will be of interest to us to see if it will continue into early April, or if it will begin to subside this week. We cannot rule out the possibility that the strong upward trend of the past five months won't be sustained in April because leverage ratio constraints created even stronger incentives for repo activity to move into the sponsored clearing.

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