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ECB MM Survey Reveals Mixed Results

The fifth Euro Money Market Study conducted by the European Central Bank indicates that aggregated turnover in the euro money market stagnated in the second quarter of 2004 compared to Q2 2003, the time of the last survey. The underlying data from the survey reveals mixed results, with the overnight interest rate, cross currency and FX swaps markets showing a decline in turnover, however turnover in the unsecured, secured, other interest rate swap, FRA and short term securities markets showed an increase.
The survey was conducted by the ECB and the 15 national central banks that were members of the European System of Central Banks (ESCB) and obtained results from 124 banks from the Eurozone, Sweden and United Kingdom.
One of the notable developments in the latest survey is the marked contraction in turnover in the overnight interest rate swap segment after a strong increase in Q2 2003, the ECB says in its report, adding that this was probably linked to a reduced level of interest rate speculation in the 2004 survey period. ‘The creation of a new benchmark (the EONIA Swap Index) by EURIBOR-ACI for the overnight interest rate swap market will probably further stimulate the development of this market segment,’ the report states.
The new index could promote the development of the swap market in three ways, the report claims. Firstly, it will serve as a controlling and valuation tool and set the basis for market conformity checks by participants against an official reference rate. The fixing time of 16.30 CET ideally supports this function, the ECB says.
Secondly, it will lead to product development and market enhancements. A new EONIA swap FRA product is already planned between two counterparties. These parties are contracting an EONIA swap rate for an agreed period and notional amount for a future date. Two value days before the starting date of the EONIA swap, this contract will be fixed against the EONIA Swap Index. The contract will be settled in cash. Its settlement amount will be calculated from the difference between the agreed rate and the actual index. No EONIA swap position will result from the settlement of this deal. The new index will also be used as a reference rate for longer-dated interest rate swaps. A revival of the very active French TAM (Taux Annuel Monétaire) swap market is also under consideration. Also, the basis swap market is expected to see additional flow volumes resulting from a precise basis perception of the market participants.
Finally, the new index will serve as a benchmarking tool for the derivatives markets similarly to the EURIBOR and Eurepo indices at the short end of the European yield curves.
Trends
The ECB points out that one of the structural developments observed from the survey with regard to money market products is that bid-offer spreads continue to be pressured, reflecting, it says, a further increase in liquidity in these market segments.
Another factor behind this could be the growth in electronic trading in this segment. ‘There was remarkable growth in the use of electronic trading systems in the secured market in the last two years,’ it states. ‘However, while electronic trading accounts for a very large share of total activity in this market, it remains marginal in most of the OTC derivatives markets.’
Two changes were made to the 2004 survey. For the first time, data on tri-party repos were collected and included as a separate asset class along with bilateral repos. Secondly, in the qualitative part of the survey, a question about the share of transactions executed spot and forward was also added.
The ECB stresses that the quantitative data published were not obtained from the standard reporting systems of credit institutions. Collecting data from a cross section of institutions implies that the survey does not provide comprehensive information on volumes in the euro area, rather the purpose is to highlight trends affecting the market’s structure. It further points out that although 124 banks were surveyed, they did not all complete every part of the survey.
The ECB says that a five-year comparison of turnover in the unsecured money market showed moderate growth (+7%) in trading volumes. A deeper analysis highlights some interesting phenomena behind the overall data. The moderate growth is the result of a large decline in market activity in the second quarter of 2002, followed by steady growth in the last two years. As indicated in the 2002 money market study, the environment of great uncertainty after the attacks in the United States on September 11 affected market activity negatively in 2002. The decline was more pronounced for lending activity (-26%) than for borrowing activity (-13%). Since the second quarter of 2002, however, activity on the unsecured market has experienced a relative recovery, with trading volumes returning to the daily turnover prevailing in 2001.
The survey confirms the upward trend in turnover in the secured market. Between the second quarter of 2000 and the second quarter of 2004, overall activity in the secured market increased by 147%. Since 2000, reverse repo transactions increased by a yearly average of 22%, while repo transactions grew by a yearly average of 28%. The growth of the repo market in 2004 was, however, less significant than in the previous year. While the rate of growth was around 24% for reverse repos and 67% for repos from 2002 to 2003, the rate of growth from 2003 to 2004 was only around 4% and 14%, respectively.
One of the reasons for the lower growth rates, the ECB says, is that the secured market has become a more mature market. Another factor is that 2003 was a year of robust growth in the secured market compared with other market segments (in particular the unsecured market) as banks tried harder to reduce risks in their balance sheets.
The surveys for the period 2000-04 showed that borrowing activities for the panel of banks continued to be higher than lending activities. This development was, however, more pronounced in the second quarter of 2004 when repos exceeded reverse repos by 49%, as against 37% in the second quarter of 2003.
Possible explanations for the robust growth in the secured money market, some of which have already been put forward in previous studies, are:
• The ongoing securitisation/disintermediation process, in particular the pattern of growth in the underlying securities markets in Europe;
• The need to limit credit risk exposures and constraints resulting from capital adequacy requirements;
• Bank treasurers’ growing desire to maximise returns on their securities holdings (more specifically their return on assets);
• The increasing integration of this market segment in the euro area, as demonstrated in the qualitative part of this survey; and
• A wider and more accepted use of tri-party repos as a means of reducing settlement problems.
In 2004 the overall tri-party repo business grew strongly versus 2003, rising by 173% for reverse repo transactions and by 125% for repo transactions. The share of tri-party repos in total reverse repo activities rose from 2% in 2003 to 5% in 2004 and, in the case of repo activities, from 8% to 15%. It should be borne in mind, however, the ECB warns, that only one in five banks that reported data on the secured market reported turnover in tri-party repos.
The rise in tri-party repo activity over the last two years is confirmed by the June 2004 European Repo Council survey. According to this survey, 11% of total outstanding business was settled through tri-party repo arrangements, compared with 6% in June 2003. However, it should be added that one institution accounted for most of the growth in tri-party repo activity in 2004.
There was a strong concentration of tri-party repos at short-term maturities (between overnight and one week). In 2004, 71% of the deals were performed in this maturity band. The maturity analysis also shows a focus on maturities over three months, which is mainly due to the fact that tri-party agreements allow for a switching of collateral in transactions with longer maturities.
After rising by 150% in 2003, the OIS volume fell by 34% in 2004. The ‘up to one month’ maturity band explained this development, with a 166% rise in volume in 2003 and a 40% fall in 2004. The share of this segment rose from 48% in 2002 to 52% in 2003, before falling back to 47% in 2004. The temporary move to shorter maturities in 2003 was also reflected in the evolution of the average maturity, which dropped to 75 days in 2003, compared with around 90 days in 2002 and 2004. This shift was probably linked to the speculation about an imminent change in ECB interest rates in 2003.
The more detailed 2004 data (which broke down the one month data into two segments) showed a shift in market share from the ‘one week to one month’ segment (whose market share fell from 43% in 2003 to 28% in 2004) to the ‘up to one week’ segment (whose share, despite the overall shift to longer maturities in 2004, rose from 15% to 18%). Given that banks also use the OIS market for hedging their liquidity position, this relative strength of the ‘up to one week’ segment may be linked to the shortening of the maturity of the Eurosystem’s main refinancing operations from two weeks to one week in March 2004.
The volume of transactions in the secondary market for short-term securities has continued to expand at a fast pace. Compared with the 2003 figures, average daily turnover for all types of short-term securities increased by 48% in 2004. Turnover in bank securities recorded a 71% rise over 2003, surpassing for the first time the daily turnover in T-bills (up 21% in 2004). Transactions in corporate paper also exhibited a high growth rate (64%). The increased turnover in bank securities cannot be attributed alone to a rise in the volume of issuance, as the growth of the issuance amount was moderate in 2004.
Structure
Overall, activity in the euro money market seems to have become less concentrated over the last few years, the report states, however, there are still large differences across market segments. Despite the slight increase in the degree of concentration of the unsecured segment in the second quarter of 2004, this segment remained by far the least concentrated, followed by the secured and OIS segments. The FX swap segment experienced a significant decrease in the degree of concentration, reaching a similar level to the OIS and secured segments. Indeed, the market share of the top 10 institutions in the FX swap segment decreased from 72% in the second quarter of 2003 to 64% in the second quarter of 2004. However, some segments of the euro money market continued to show a high degree of concentration, in particular the OTC derivatives markets.
In terms of turnover, the 10 most active institutions in the FRA, other IRS and cross-currency swap segments continued to hold a market share of above 70%. The concentration in the other IRS segment even increased, with the market share of the 10 largest institutions rising from 73% in the second quarter of 2003 to 79% in the second quarter of 2004. More than half of all trading activity in the other IRS segment in the second quarter of 2004 was concentrated among three institutions.
The geographical counterparty breakdown of the turnover in the second quarter of 2004 shows the structure remained broadly unchanged across all segments except the short-term securities and cross-currency swap segments, when compared with the second quarter of 2003.
The bulk of business continued to be carried out with counterparties from the euro area, according to the survey. The most relevant change in the geographical counterparty structure was the loss of predominance of transactions with national counterparties in the short-term securities segment. Indeed, in the short-term securities and cross-currency swap segments, the share of transactions carried out with counterparties from the euro area surged to the highest levels across all market segments, indicating better integration despite various existing obstacles.
The fact that the proportion of business in the secured market carried out with national counterparties remained much larger than for other market segments reveals that the integration of national repo markets across the euro area continues to be a slow and complex process, the ECB states, despite the considerable progress registered in the last years.
As for the trading structure, in general the survey showed that electronic trading transactions continued to grow in most of the market segments in the second quarter of 2004. However, their share of total activity remained rather small in some segments. Indeed, in segments other than the secured market, electronic trading still accounts for the smallest share of overall activity. It is worthwhile noting, the ECB says, that in the secured market the use of electronic trading systems showed a strong increase in the last two years, rising from 13% of total activity in the second quarter of 2002 to 42% in the second quarter of 2004.
Direct trading continued to be the most important way of carrying out business in the unsecured, other IRS, cross-currency swap and short-term securities segments. In the OIS and FRA segments, nearly half of the turnover is traded through voice brokers, which is also an important way of conducting transactions in the other IRS segment. A comparison with 2003 shows that voice brokers gained ground in 2004 in the secured, unsecured and OIS segments, mostly at the expense of direct trade.

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