The City gave birth to a new market yesterday. But even though it has been billed by the Bank of England as "the most significant liberalisation in the gilt market since Big Bang", the gilts repo market started life without much ado.
"It was like watching paint dry," said Nigel Richardson, head of bond research at Yamaichi International. "It was a day of people finding their feet, testing the system."
Investors' attention was more focused on political worries about an early election. The March long gilt future lost a third of a point and the differential between UK and German yields widened.
Despite this slow start to the new repo market, "it will affect everything," said Euan Harkness, chairman of the Gilt Edged Market Makers' Association. "If you're not on top of it, you aren't going to be aware of stock shortages developing."
With the advent of open gilt repo trading, any market participant can enter into an agreement to sell and repurchase gilts. This allows investors and traders to raise finance from their holdings of gilts by selling them as collateral and permits them to borrow stock to cover short positions.
Until now, only the 20 gilt-edged market makers could use stocklending and borrowing facilities offered by the eight Stock Exchange money brokers. However, this market structure was "viewed as very opaque by international investors," said Peter D'Amario, repo marketing director at BZW. "Now with the market opened up you've got an efficient pricing mechanism emerging."
Although there is no set limit to the length of repo contracts, the average is expected to be between a week and ten days. With the repo rate the key intervention mechanism for other central banks, the Bank of England is widely expected to follow suit once the market is in full swing.
The creation of the new market is the second in a three-pronged attempt, initiated by the Treasury, to cut borrowing costs. It follows the auction calendar and maturity schedule for gilts and comes ahead of a new gilts stripping facility.
All three changes are designed to bring the gilts market into line with international practice. According to Mr D'Amario, repo trading, long a feature of the US Treasury market, has grown "geometrically" in the past decade. In recent years, the French have also reformed their bond market to introduce repo trading.
The Treasury's ultimate goal is to drive down borrowing costs.