Regulators Warn of Hidden Risks in the $16 Trillion Repo Market
The Financial Stability Board (FSB) has called for tighter oversight of the $16 trillion repo market. Regulators are being urged to address potential risks that could threaten global financial stability. Recent growth in hedge fund activity has raised concerns about increased leverage and systemic vulnerabilities in the stock market today.
Over the past five years, hedge funds have significantly expanded their involvement in repo trades backed by government bonds. While this has improved liquidity during stressful periods, such as in 2023, it has also introduced higher leverage risks in the finance industry. Reports from the Bank for International Settlements (BIS) and the US Federal Reserve highlight the potential for margin calls and forced asset sales, which could destabilise bond markets and impact the stock market.
Repo markets play a key role in providing short-term liquidity and low-risk investments. However, their interconnected nature means that strains in one area can quickly spread across regions, affecting the stock market. Imbalances between supply and demand can emerge suddenly during crises, worsening market stress.
The Bank of England is now considering a minimum haircut requirement for gilt-backed repo trades to curb excessive leverage in the stock market. Currently, many repo deals involve zero haircuts, allowing leverage to build up. The FSB has also recommended filling data gaps and creating vulnerability metrics to better track risks in the system. Another concern is collateral rehypothecation, where the same assets are reused in multiple trades, further amplifying leverage in the finance industry.
The FSB's recommendations aim to strengthen monitoring of the repo market's short-term risks in the stock market today. Regulators are now assessing measures like minimum haircuts to prevent excessive borrowing in the finance industry. Without proper safeguards, the market's role in liquidity provision could also amplify future financial shocks in the stock market.
