Global Financial Watchdog Warns of Risks in $16 Trillion Repo Market

Risks Identified in the Repo Market

LONDON, Feb 4 (Reuters) - Vulnerabilities are building across the $16 trillion market for government bond-backed repurchase agreements, a global financial watchdog warned on Wednesday, highlighting rising leverage among hedge funds and growing dependence on short-term funding.

Market Vulnerabilities and Concerns

The warning from the Financial Stability Board, which coordinates regulatory policy among G20 authorities, follows repeated alerts from central banks and regulators about a market that underpins bond-market liquidity by letting firms borrow cash against sovereign debt.

Regulatory Responses and Recommendations

The FSB said that roughly $16 trillion in government bond-backed repos were outstanding at the end of 2024, up about 20% since 2022. The U.S. accounts for nearly 60% of activity, followed by Britain and the euro zone and then Japan.

Impact of Hedge Fund Activity

The watchdog said in a report it had identified several vulnerabilities that could pose risks to the broader financial system, including the build-up of leverage, demand and supply imbalances and high concentration of borrowers, lenders and intermediaries, increasing the probability of market-disrupting operational failures or financial distress.

Future Regulatory Measures

The report highlights how quickly repo markets were hit in several recent episodes of market stress, including the U.S. repo rate spike in September 2019, Britain's Liability-Driven Investment fund crisis in September 2022, and volatility in the euro zone repo market in September 2022.

Authorities should consider closing data gaps, strengthening surveillance capabilities, and addressing vulnerabilities related to liquidity imbalances and leverage, the FSB said.

In December, the Bank of England said that leveraged activity by hedge funds in the gilt repo market had reached its highest on record at nearly 100 billion pounds ($132 billion) the previous month, dominated by a small number of mostly U.S.-managed hedge funds reliant on very regular refinancing.

If that financing suddenly dried up, hedge funds might have to dump British government bonds in a fire sale, the BoE warned.

In September, it set out options to more tightly regulate British government bond-backed repo markets. BoE Governor Andrew Bailey chairs the FSB.

The U.S. Securities and Exchange Commission has ordered central clearing for most repo and cash transactions in U.S. Treasuries by the middle of 2027.

(Reporting by Phoebe Seers. Editing by Mark Potter)