ECB official open to offering liquidity aid to non-banks

A deputy director at the European Central Bank has said he’d “never say never” to opening up liquidity support to non-banks such as life insurers and pension funds following recent moves by the Bank of England (BoE).

“Never say never: we are attentive to that, but I would not see that as imminent,” said Thomas Vlassopoulos, deputy director general for market operations at the ECB, in response to a question about whether the central bank was considering allowing life insurers access to liquidity support. He was speaking in a personal capacity at the Risk Live Roadshow, held in Berlin on October 1 by sister title Risk.net.

On July 24, the BoE published details of a provisional design of a repo facility that would allow non-bank financial firms to borrow cash using UK government bonds. Insurance companies, pension funds and liability-driven investment (LDI) funds would be able to use the facility if the gilt market experienced a repeat of the dysfunction that seized it two years ago.

The chaos of September 2022 saw UK pension funds face margin calls as large as £100 million ($130 million) after falls in the value of UK gilts and sterling hit valuations of derivatives and leveraged repo positions. The BoE intervened at the end of that month by buying long-dated gilts, which stemmed the bond and currency selloff. The UK central bank expects applications to access the new facility in the fourth quarter of this year.

The ECB allows national central banks to provide emergency liquidity assistance to eurozone lenders – but the aid is only available to solvent banks that are facing shortages in liquidity. Other facilities that the ECB has for injecting or removing liquidity in financial markets are also only accessible by banks. 

Although Vlassopoulos left the door ajar for an extension of liquidity support, he said the current system of “intermediated access” – whereby banks can tap the ECB’s liquidity and pass it on to the broader financial system – “works reasonably well”. He also didn’t see the conditions necessitating the BoE’s move as being present in the eurozone.

“We are in a slightly different world,” said Vlassopoulos. “The LDI type of phenomena we consider are not an imminent risk. In some countries, these structures are important, but in the euro area, they are not as important.”

The liquidity strain on non-bank firms from margin calls on their derivatives positions has become a concern in some areas of the industry. Months before the UK’s gilt crisis, energy firms in Europe were under pressure from whipsawing energy and commodity prices following Russia’s invasion of Ukraine. Less than a month after Russia launched its February 2022 invasion, the European Federation of Energy Traders wrote to central banks and public institutions asking them to provide “emergency liquidity funding”. Energy firms were facing steepening margin calls on derivatives cleared at central counterparties after the price of benchmark gas contracts more than doubled on European exchanges in a matter of days.

At the time, the ECB dismissed the requests, and governments later provided emergency credit facilities to energy firms.

Global regulators are currently pondering how to address the dash for cash during times of panic. The Financial Stability Board published proposals in April this year setting out recommendations for improving the preparedness of firms to meet margin and collateral calls ahead of crisis events.

From QE to QT

Vlassopoulos’s comments came following a speech delivered at the Risk Live Roadshow where he explained that the ECB’s reversal of quantitative easing – where the ECB injects cash into the market by buying bonds – hasn’t led to a draining of liquidity in bond markets.

“Since the start of quantitative tightening, bond market liquidity has, in fact, generally improved,” he said.

He added that liquidity conditions had showed “some sensitivity” to the announcement of snap elections in France in June and the unwinding of the so-called carry trade at the start of August: “Ultimately, however, the effects of both of these shocks have been short-lived.”

One explanation for the resilience in liquidity conditions is that European dealers have capacity to warehouse securities on their balance sheets. Vlassopoulos cited a fall in the amount of European government bond debt on primary dealers’ balance sheets as a proportion of total assets since 2018. In contrast, the share of US dealers’ balance sheet comprising US Treasuries has increased over recent years, leading to concerns over the shallowness of the market’s liquidity.

“In the euro area, dealer intermediation capacity is not particularly stretched by historical standards, and can therefore provide support liquidity in government bond markets,” said Vlassopoulos.

This article first appeared in sister title Risk.net