Bank of England says action needed on gilt repo market regulation

By David Milliken

LONDON, July 17 (Reuters) - Bank of England Deputy Governor Sarah Breeden said "doing nothing is not an option" for regulating the British government bond repo market, due to the continued risk that it causes bond trading to dry up in a financial crisis.

Net borrowing in the gilt repo market — where traders seek to profit from moves in interest rates, and investors turn bond holdings into temporary cash — totals around £200 billion ($270 billion) according to BoE data, £85 billion of which is by hedge funds.

Last year, the BoE set out proposals for tighter regulation of the market, after the central bank had to intervene in 2020 and 2022 at the start of the COVID-19 pandemic and following Prime Minister Liz Truss' mini-budget.

However, the proposals have led to pushback from the finance industry, and Breeden said some reforms such as greater use of central clearing "will likely take years, not months".

BoE research showed wide use of central clearing would have cut dealers' risk exposure by 40% in 2020 at the start of the COVID-19 pandemic and by a further 20% if gilt repos had more standard maturity dates, she said.

Breeden's remarks, published in an article on Friday on the BoE's website, were based on a speech she gave to the International Capital Market Association industry conference in May.

Breeden said she disagreed with the industry practice of applying zero or near-zero "haircuts" — the risk margins applied to repo trades — which dealers sometimes justified by pointing to offsetting assets elsewhere in their portfolios.

If that argument held, raising gilt repo margins should allow banks to lower them elsewhere at no net cost, she said, adding: "Commercial pressures may be contributing to the prevalence of near-zero haircuts in the non-centrally cleared gilt repo market."

Breeden also disputed the view of some in the industry that moving towards central clearing of gilt repo trades — rather than the current practice of market participants settling trades directly with each other — would deliver few cost savings and instead make the market sell off faster in a downturn.

($1 = 0.7446 pounds)

(Reporting by David Milliken; Editing by Hugh Lawson)