BoE pushes for stronger gilt repo liquidity amid rising risks

The UK gilt repo market is critical for financial stability, underpinning the cash gilt market and monetary policy transmission.

Past episodes, like the March 2020 'Dash for Cash' and 2022 LDI crisis, exposed how structural liquidity vulnerabilities can amplify shocks, requiring central bank intervention.

While recent resilience is encouraging, significant structural changes persist.

Globally active hedge funds now account for up to 60% of secondary market volumes in the gilt cash market, with net borrowing of £85 billion in the repo market.

This growing footprint of leveraged, price-sensitive players introduces new risks, as their positioning can adjust quickly, amplifying volatility and creating spillovers.

The Bank's system-wide exploratory scenario (SWES) exercise showed that increased hedge fund repo borrowing could exhaust banks' market-making capacity in severe stress.

The Bank of England's discussion paper proposed reforms for gilt repo resilience, focusing on central clearing and minimum haircuts.

Industry feedback highlighted three key challenges.

Some argued netting benefits from central clearing are limited, but the Bank asserts these are significant, citing an £81 billion increase in nettable repo during the 'Dash for Cash'.

Concerns were also raised about zero or near-zero haircuts in the non-cleared market, which the Bank suggests may reflect competitive pressures.

Finally, the procyclical nature of CCP initial margin calls was seen as exacerbating stress, though the Bank views this as a necessary feature with built-in mitigations.