As we warned here most recently, the shadow-banking system remains the most crisis-catalyzing part of the markets currently as collateral shortages (and capital inadequacy) continue to grow as concerns. In recent weeks, between The Fed, Basel III, and the FDIC, regulators have signalled the possible intent to change risk, netting, and capital rules that could have dramatic implications on the repo markets and now, it seems, the SEC has begun to recognize just how big a concern that could be. As Reuters reports, the SEC urged funds and advisers last week to review master repurchase agreement documentation to see if there are any procedures to handle defaults, and if necessary, prepare draft templates in advance.
A retrenchment in repo markets is unwelcome news for the liquidity of the underlying securities. Most repos, around 80%-90%, are against government-related collateral and it is the repo market which makes government securities relatively more liquid by allowing fast and efficient financing and short covering. It is not accidental that trading volumes in bond markets are so closely related to the outstanding amount of repos.
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