Bank of England Proposes Stricter Repo Market Oversight

February 26, 2025
10:01 am

Implications for Systemic Stability

The Bank of England (BOE) has unveiled a comprehensive regulatory overhaul targeting gilt repo markets, signalling a pivotal shift toward mitigating systemic risks posed by non-bank financial institutions (NBFIs) and hedge funds. These reforms, detailed in a December 2024 discussion paper and subsequent policy statements, prioritise stricter haircut requirements, enhanced collateral management, and the rollout of emergency liquidity facilities.

This report analyses the BOE’s proposed measures, their alignment with global standards, and their potential impact on financial stability and market behaviour.

Sir David Ramsden delivered his remarks titled “Getting the balance right: ensuring the Bank’s balance sheet can support financial stability” at the Official Monetary and Financial Institutions Forum (OMFIF) in London on December 9, 202412. The speech was part of a keynote address to policymakers, financial institutions, and academics, focusing on the Bank of England’s evolving role in mitigating systemic risks amid structural shifts in financial markets.

Regulatory Drivers: Addressing Leverage and Market Fragility

Systemic Risks from Near-Zero Gilt Repo Haircuts

The BOE’s push for higher haircuts on gilt repos follows its analysis of Securities Financing Transactions Regulation (SFTR) data, which revealed that bilateral transactions between banks and hedge funds often feature haircuts of 0–2% for government bonds—far below levels commensurate with counterparty risks 2 12. This practice contravenes BOE guidelines that mandate collateral valuations reflecting both market volatility and borrower risk profiles 7.

Historical crises underscore the urgency:

The 2021 Archegos collapse, driven by unchecked leverage in equity swaps 7.
The 2022 UK gilt market crisis, where liability-driven investment (LDI) funds faced £1.4 trillion in margin calls 14.
The January 2025 gilt yield spike, exacerbated by hedge funds’ leveraged short positions 7.

Deputy Governor Dave Ramsden emphasised that these episodes highlight the “hidden leverage” embedded in repo markets, where risk concentrations now mirror pre-2008 banking sector vulnerabilities 8 16.

Transition to a Repo-Led Operating Framework

Phasing Out QE’s Legacy Risks

The BOE’s December 2024 discussion paper outlines a transition from a supply-driven reserves framework—anchored by quantitative easing (QE)—to a demand-driven, repo-centric model 1 5. Key components include:

Short-Term Repo (STR) Facility: Launched in 2022, this provides unlimited reserves against Level A collateral (e.g., gilts) at Bank Rate, ensuring monetary control during QT 1 10.
Indexed Long-Term Repo (ILTR) Facility: Recalibrated to supply reserves for financial stability, with weekly operations and 6-month tenors to reduce rollover risks 10 11.

This shift eliminates interest rate risk from the BOE’s balance sheet—a lesson learned from £701 billion in unrealised gilt losses during 2022–2024 5. By 2025, the STR and ILTR will supply ~75% of system reserves, replacing QE’s passive liquidity injections 1.

Operational Challenges for Banks

UK Finance’s response highlights concerns among smaller banks about operational readiness for weekly ILTR participation 11. While larger institutions view repo usage as “business as usual,” smaller firms face IT and collateral management hurdles. The Prudential Regulation Authority (PRA) has urged firms to conduct stress tests aligning with the BOE’s 2025 timeline 10.

Contingent NBFI Repo Facility (CNRF): A Safety Net with Ambiguities

Design and Eligibility Criteria

Scheduled for January 2025 activation, the CNRF targets insurers, pension funds, and LDI funds holding >£2 billion in gilts 14 15. It provides liquidity during “severe gilt dysfunction” but leaves critical questions unresolved:

Pricing: Determined ad hoc during activation, raising uncertainty about penalty rates 14.
Collateral Scope: Initially limited to gilts, though Ramsden hinted at future expansions to corporate bonds or equities 15.
Stigma Management: Participant identities will remain confidential to prevent market speculation 15.

Hedge Funds: A Delayed Inclusion

Despite hedge funds accounting for 30% of gilt trading volumes, they remain excluded from the CNRF’s first phase 3 8. The BOE cites operational complexity but faces criticism for lagging behind the Federal Reserve’s Standing Repo Facility, which serves broker-dealers7.

Haircut Reforms: Aligning with FSB Standards

From Guidelines to Enforcement

The BOE’s haircut proposal adopts the Financial Stability Board’s (FSB) 2014 framework, which mandates minimum haircuts for non-centrally cleared repos to curb shadow banking risks 9. However, BOE enforcement mechanisms go further:

Risk-Weighted Haircuts: Longer-dated gilts (e.g., 30-year bonds) face higher haircuts due to duration risk, potentially reaching 3–5% versus the current 0–2% 2 12.
Counterparty Differentiation: Hedge funds and multi-manager funds will face steeper charges than insurers, reflecting their higher leverage ratios 7 16.

Market Impact Analysis

JPMorgan estimates that a 2% haircut increase could reduce hedge fund leverage by 15–20%, trimming gilt repo volumes by £50–70 billion annually. Banks, however, may offset revenue losses via wider bid-ask spreads, particularly in inflation-linked gilts 16.

Comparative Global Perspectives

Canada’s Tri-Party Repo Model

The Bank of Canada’s adoption of the Canadian Collateral Management Service (CCMS) offers a contrast. By centralising collateral mobility across repos and derivatives margins, Canada has reduced fragmentation without imposing haircut floors—a model the BOE studied but rejected due to the UK’s larger NBFI sector 1 11.

EU’s SFTR vs. BOE’s Approach

While the EU’s SFTR improved repo transparency, its lack of haircut mandates allowed systemic risks to persist. The BOE’s proactive stance—combining disclosure requirements with enforceable haircuts—sets a new benchmark for hybrid regulation 2 12.

Criticisms and Unresolved Issues

Moral Hazard Concerns

Critics argue the CNRF creates a “liquidity illusion,” encouraging risk-taking among NBFIs. Former MPC member David Miles warned that backstops without haircut reforms could replicate the 2008 crisis dynamics 15.

Implementation Timeline Risks

With ILTR recalibration and CNRF onboarding both slated for 2025, market participants question the BOE’s capacity to manage overlapping transitions. Delays could exacerbate gilt volatility during fiscal expansions 10 11.

Conclusion and Policy Implications

The BOE’s repo market reforms represent a paradigm shift in post-QE central banking, prioritising active liquidity management over passive balance sheet expansion. Success hinges on:

Haircut Enforcement: Ensuring banks comply with risk-sensitive collateral valuations.
CNRF Transparency: Clarifying activation triggers to balance credibility and flexibility.
Global Coordination: Aligning with FSB and Basel Committee standards to prevent regulatory arbitrage.

These measures position the UK as a testbed for mitigating NBFI-driven systemic risks—a challenge central banks worldwide will confront as QT accelerates. Investors should monitor Q2 2025 ILTR usage data and hedge fund leverage ratios for early signs of market adaptation.

Citations:

Glenn Handley

At SecFin Solutions, Glenn Handley epitomises expertise and innovation in global finance and management consulting.

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