Are long term liquidity swaps the future of bank funding, or an emerging bubble? We have no idea. This isn’t a failing of investigative spirit at EuroWeek — nobody has a clue.
No bank discloses figures on how they use liquidity swaps; they appear nowhere in bank accounts. Asking one leading European bank for a number met a blank wall — disclosing even the thinnest details meant breaching material disclosure rules.
Pushing market participants for a figure results in hand-waving and guesstimating.
Trades are typically in the €300m–€1bn range, with a few banks prepping deals up to €3bn. Bank of Ireland, all but locked out of conventional capital markets, managed to obtain €2.9bn of long term repo funding.
But trades are not recorded anywhere. There is no overall repository, no centralised reporting mechanism, no industry association. ICMA’s European Repo Council is the closest approximation, but the last repo market survey from the ERC recorded the following: “The survey did not show an increase in longer-term transactions despite reports of a rising volume of such transactions. It may be that these transactions are not being captured by the survey because of the way they are booked or structured. This is being investigated.”
As a new market emerges, it is up to market participants and regulators to determine its shape, customs and practices.
Liquidity swaps are slippery — they can be structured as triparty or bilateral repos, ISDA swaps, or securities lending deals, alongside other bespoke documentation — but the scope of the market and the players involved should be public.
Right now, the presumption is that because the transactions are between two parties, nobody else needs to know. Discretion like this is tempting, but wrong.
Bank investors need to know, because it has a bearing on the financial strength of the institution. Rating agencies and regulators need to know, for exactly the same reason. Market participants need to know, because observable volumes and prices promote liquidity and a wider market.
Liquidity swaps could easily end up with an image problem — rehypothecation and carefully drawn distinctions between ‘beneficial interest’ and ownership looks suspiciously like gaming the system. Regulators will gladly stomp on the nascent market, erring on the side of caution towards anything that looks like ‘financial innovation’.
But done right, they’re healthy and wholesome.
Liquidity swaps mean another funding channel for banks, more resilient than even covered bonds. They mean longer term funding, tailored to liquidity assets. They mean lending against specific assets with the flexibility to take in anything, no matter how illiquid or hard to value.
The market is already moving in that direction — Colin Fleury of Henderson Global Advisors says his firm has had conversations about acting as an independent advisor and collateral monitor in this business — but more could be done to promote transparency and standardisation.
Market players should act soon to shine a light on the market, to pre-empt overzealous regulators who might want to do the same. If they illuminate something nasty, the sooner the better. But this is the way to get respectability.