SESFOD@10 – credit terms and conditions in euro-denominated securities financing and over-the-counter derivatives markets since 2013

Published as part of the ECB Economic Bulletin, Issue 6/2023.

Credit terms and conditions are an essential component of financing conditions and central to determining market participants’ risk appetite. Financing conditions affect market participants’ investment decisions. Looser credit terms and conditions may favour the build-up of leverage and increased risk-taking in the financial system. Building on the lessons from the global financial crisis, the ECB has been running the three-monthly survey on credit terms and conditions in euro-denominated securities financing and over-the-counter derivatives markets (SESFOD) since March 2013.^[1]

Securities financing transactions (SFTs) are secured transactions in which assets are exchanged for cash. In economic terms, SFTs represent a loan which is collateralised by assets (e.g. bonds or shares). SFTs encompass four different transaction types: repurchase agreements (repos), securities lending, buy/sell back transactions and margin lending.^[2] Euro-denominated repo transactions currently represent the largest segment of the euro money market with an outstanding amount of around €2 trillion at the end of 2022. Secured trades have become more popular since the financial crisis owing to a greater preference for mitigating counterparty risk through collateralisation. In addition to providing secured funding, repo transactions also enable market participants to source specific securities. Lastly, the secured money market segment plays a central role in monetary policy implementation and transmission, as does the unsecured money market segment.^[3]

Over-the-counter (OTC) derivatives are financial instruments whose price depends on an underlying asset and which are traded outside of regulated exchanges. Derivatives are financial contracts linked to the fluctuation in the price of an underlying asset or a basket of assets (e.g. interest rates instruments, equities or commodities). OTC derivatives - which are privately negotiated and not traded on an exchange - accounted for almost 32% of the euro-denominated derivatives markets with a total gross notional outstanding amount of €41 trillion at the end of 2022. Financial derivatives are used, among other things, for risk management, hedging, arbitrage between markets and speculation.^[4] Derivatives have a significant impact on the real economy, from mortgages to food prices.

SESFOD is part of an international initiative to collect information on the credit terms and conditions offered by firms operating in the wholesale markets. These markets are also important conduits for leverage in the financial system. SESFOD sheds light on potential risks associated with securities financing and derivatives markets, while also serving as a valuable monitoring and potential early warning tool by identifying significant changes in credit terms and conditions. Lastly, information on changes in the cost and availability of funding in wholesale markets, and in repo markets in particular, may support the analysis of monetary policy transmission and interbank funding conditions.^[5]

SESFOD can be seen as the market-based counterpart to the euro area bank lending survey (BLS).^[6] The ECB conducts several surveys^[7], among which both SESFOD and the BLS focus, in part, on credit conditions. SESFOD studies credit terms for SFTs and OTC derivatives, whereas the BLS provides information on bank lending conditions for firms and households in the euro area.

On the tenth anniversary of SESFOD, this article illustrates the developments and drivers of counterparty credit terms and conditions based on participants’ responses over time.

1 Background to the survey

SESFOD, which was developed as part of an international initiative^[8], is a predominantly qualitative survey of the activities of a sample of large banks and dealers in securities financing and over-the-counter (OTC) derivative markets. SESFOD participants are large banks and dealers headquartered in both euro area and non-euro area countries. The SESFOD panel currently consists of 27 banks. Box 1 looks at the representativeness of the survey participants in terms of their footprint in the relevant euro-denominated markets. In the aftermath of the 2008 global financial crisis, a study group of the Committee on the Global Financial System (CGFS) recommended conducting a qualitative survey on credit terms and conditions.^[9] This resulted in major global central banks using equivalent survey structures. The results from such surveys provide the basis for international comparisons. Box 2 compares responses on hedge funds from SESFOD with those from the Federal Reserve’s Senior Credit Officer Opinion Survey on dealer financing terms (SCOOS).

SESFOD covers the markets that facilitated higher leverage and risk-taking in the lead-up to the global financial crisis. Prior to 2007, the non-bank financial system (sometimes referred to as the shadow banking system) enabled the build-up of leverage and allowed increasing interconnectedness within the financial system. SFT and OTC derivative markets played a key role in these developments. SESFOD was designed to monitor risks arising from increased interconnectedness, excessive financial leverage, vulnerability to procyclicality, “repo runs” and financial conditions.

SESFOD qualitative results enrich and complement the more recently available granular data on the covered markets. Since the survey was launched, new datasets have become available which provide granular insights into the markets covered by SESFOD. These datasets include data collected under the European Market Infrastructure Regulation (EMIR), the Securities Financing Transactions Regulation (SFTR) and Money Market Statistical Reporting (MMSR).^[10] However, while price terms could be monitored through these datasets to some extent, SESFOD offers insights on non-price terms. The monitoring of non-price terms (e.g. credit limits or covenants and triggers) through quantitative datasets is much more challenging and costly. At the same time, as experienced during the global financial crisis^[11], changes in non-price terms may have a much more adverse impact than changes in price terms (e.g. haircuts or initial margin requirements).

SESFOD also provides a forward-looking perspective that cannot be offered by regulatory data. SESFOD includes questions seeking qualitative information on the future direction of credit terms for different counterparty types or on the availability of (unutilised) leverage at hedge funds. Surveyed banks are asked about their outlook, which is later compared with actual market developments. The reliability of forward-looking information is one of the focus points in Section 4

2 Survey structure

SESFOD is structured in three parts spanning different counterparty types and market segments.^[12] The first part covers credit terms across counterparty types in both SFT and OTC derivatives markets, while the second focuses on financing conditions against different types of collateral in SFT markets. The third part deals with financing conditions based on the type of underlying asset classes in OTC derivatives transactions.^[13]

Credit terms are reported from the perspective of the dealer banks participating in the survey as suppliers of credit; they are differentiated between price and non-price terms and by counterparty types. Banks participating in SESFOD report changes in the credit terms they apply to SFT and OTC derivatives transactions with counterparties belonging to one of six counterparty types: (i) banks and dealers, which are the main financial intermediaries in wholesale markets; (ii) hedge funds; (iii) insurance companies; (iv) investment funds (including exchange-traded funds), pension plans and other institutional investment pools; (v) non-financial corporations; and (vi) sovereigns. In addition to the counterparty breakdown, credit terms are also differentiated into price and non-price terms. Price terms refer to the compensation demanded for bearing risk, e.g. financing rates or spreads; non-price terms refer to contractual provisions used to mitigate risk exposures, e.g. haircuts, provisions on the maximum maturity of funding, covenants and triggers. To the extent that credit terms have tightened or eased, respondents are asked to provide up to three of the most important reasons why their price and non-price credit terms have changed across the entire spectrum of securities financing and OTC derivatives transaction types, selecting from a given list of eight reasons.^[14]

Aggregate survey results are expressed in net percentages of respondents. For each question, survey respondents choose from five options, for example: (i) tightened considerably; (ii) tightened somewhat; (iii) remained basically unchanged; (iv) eased somewhat; and (v) eased considerably. Net percentages are calculated as the difference between the percentage of respondents reporting “tightened considerably” or “tightened somewhat” and those reporting “eased somewhat” and “eased considerably”.

The time series of aggregate survey results since the survey launch in March 2013 enables a comparison of SESFOD results with relevant market indicators. Comparing SESFOD for the main financial intermediary counterparty types with the Euro Stoxx 50 Volatility Index (VSTOXX) illustrates that SESFOD results for financial counterparties tracked the VSTOXX index rather closely. Moreover, after some dispersion in credit terms across financial counterparties in the earlier part of the survey period, credit terms have moved in line in recent years (Chart 1, panel a).

Comparisons are also possible with the results of other surveys such as the BLS. Since the information covered by both ECB surveys also includes credit conditions for non-financial entities, it is possible to compare results from the SESFOD survey with those of the BLS. Overall credit terms for non-financial counterparties in SESFOD are not always aligned with BLS credit standards for euro area firms. Credit conditions from SESFOD are more volatile when compared with the credit standards reported in the BLS. Moreover, SESFOD results have pointed to a tightening in most quarters since 2015, whereas BLS results moved to a consistent tightening only as of 2022 and have been signalling mostly easing credit standards between 2014 and 2019 (Chart 1, panel b).

The time series of responses since the survey launch in March 2013 provide a rich basis for assessing the range of opinions among participating banks. The mapping of qualitative answers into numerical scores allows us to compute several statistics and to gauge the aggregate information collected by SESFOD.^[15] In a nutshell, dispersion across responding banks on single questions can be aggregated at the survey round level or by question theme. This approach can also be applied to subgroups of respondents, typically broken down by their jurisdiction or the national location of the headquarter. This analysis is presented in Section 3.

As the predominant response has been “remained basically unchanged”, the net percentages – as aggregate indicators of survey results – have often been based on a small number of responses either side of the response spectrum.For each survey since 2013, an average 88% of responses indicated that conditions were basically unchanged. This average is lower for questions on counterparty credit terms and highest for those on uncleared OTC derivatives (Chart 2). Given the predominance of these responses among a relatively small set of participants, we need to ensure that survey findings are not consistently driven by a subset of (individual) respondents or by the geographic domicile of the respondents.

3 Drivers of changes in bank responses

Participant opinions differ more on questions about price terms than on ones about non-price terms (Chart 3, panel a). Bank responses vary based on the questions and the geographic area of the survey participants. The standard deviation for responses to questions on price terms is higher than for those on non-price terms. Credit terms and conditions not only reflect considerations about counterparty credit risk management, but also considerations about balance sheet availability, market liquidity and competitive pressures, etc. These are further documented in Section 5. Moreover, the non-price terms and conditions agreed with established counterparties in relation to transactions or financial instruments guided by e.g. International Swaps and Derivatives Association (ISDA) agreements are adjusted very infrequently.

Views have diverged more among participants headquartered in the euro area than among participants headquartered elsewhere (Chart 3, panel b). The jurisdiction breakdown reveals a persistent difference in dispersion within groups. The most likely factors driving this wedge are differences in customer bases and in full access to the Eurosystem liquidity facilities. For the former, euro area banks compete for many small and medium-sized enterprises (SMEs), while non-euro area groups focus on larger, global clients in the “blue chips” echelon.

4 Bank expectations versus outcomes

SESFOD assesses counterparty credit terms from both a backward-looking and a forward-looking perspective. For predetermined counterparty types and for all counterparties, SESFOD asks respondents to assess overall, price and non-price credit terms over the preceding three months and to share their expectations for these terms over the forthcoming three months. This section assesses the degree to which expectations expressed by participants at the individual (micro) and at the aggregate (macro) levels have leading indicator properties.

Individual participants predominantly and correctly anticipate unchanged counterparty credit terms, while only rarely correctly anticipating directional changes. Incorrect anticipations were more common for price than for non-price terms: on average, respondents correctly anticipated unchanged price and non-price terms in 67.7% and 83.7% of the cases respectively. Moreover, respondents’ expectations were on average directionally wrong in 28.5% of the cases for price terms and in 14.2% of the cases for non-price terms. Correctly anticipated directional changes were more often correct on the tightening side (5.1% of the cases for price and 2.1% for non-price terms) than on the easing side (2.4% and 0.9%) (Chart 4).

Aggregate expectations have consistently displayed leading indicator properties (Chart 5). Aggregate opinions, often described as the “wisdom of the crowd”, could balance out individual underperformances and deliver higher accuracy. On average, respondents have rightly anticipated the overall credit terms across counterparty types in 76% of the cases. In 24% of the cases, respondents’ anticipations did not materialise without erring either on the easing or on the tightening side. In 13% of the cases, the observed credit terms tightened less than expected, whereas in 11% of the cases they eased less than expected. This good aggregate anticipation might be driven by poor individual expectations balancing each other out, or also by self-fulfilling expectations and endogeneity, as SESFOD participants are large market participants.

5 Drivers behind changes in counterparty credit terms and conditions

Survey responses may reveal cyclicality in the relative importance of drivers of credit terms and conditions or may be indicative of underlying structural market developments. Respondents are asked to provide the three most relevant drivers behind an easing or tightening in credit terms as appropriate by selecting from a list of eight options. Analysing these responses over time reveals that some of these drivers are cyclical (e.g. the role of general market liquidity and functioning) (Chart 6, panel a). Beyond this cyclicality, the recurring mention of individual drivers as the most relevant reasons for tightening or easing can help identify structural trends in markets.

General market liquidity and functioning as well as competition from other institutions have been identified as the main drivers influencing price and non-price terms over the life of SESFOD. Since the start of SESFOD, survey participants have named general market liquidity and functioning as the main driver for an easing or tightening of price and non-price terms. Additionally, competition from other institutions and availability of balance sheet space were consistently mentioned by the surveyed banks (Chart 6, panel a). For price terms applied to transactions with bank and dealer counterparties, responses show that balance sheet availability and the adoption of new market conventions, in particular during the early implementation phases of Basel III, were important drivers in the early years of SESFOD. In line with the results for all counterparties, general market liquidity and functioning has had the main impact on price terms in recent years (Chart 6, panel b).

6 Concluding remarks

SESFOD surveys a small but representative sample of market participants. The analysis of responses since the launch of the survey in 2013 validates the conduct and use of the survey for financial stability (as it shows increases in risk-taking and build-up of leverage), for market functioning and for monetary policy (as it shows changes to financing conditions).

• The infrequent changes, along with the “wisdom of the crowd” phenomenon observed for developments in price and non-price credit terms, emphasise the value of the qualitative SESFOD information as a warning light for future unfavourable developments.
• Coupling the qualitative survey with quantitative regulatory reporting data will further enrich the assessment of credit terms in euro-denominated SFT and uncleared OTC derivatives markets and enable a better understanding of the financing conditions prevailing in financial markets.

1. See the special feature entitled “New ECB Survey on Credit Terms and Conditions in Euro-denominated Securities Financing and Over-the-Counter Derivatives Markets (SESFOD)”, Financial Stability Review, ECB, May 2013.

2. For definitions, see Article 3 of the Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012 (OJ L 337, 23.12.2015, p. 1).

3. See Euro money market study 2022, ECB, April 2023.

4. See Derivatives / EMIR, European Commission.

5. Analyses that drew on SESFOD information include Section 2.1 in the Financial Stability Review, ECB, November 2019 and the boxes entitled “Recent trends in credit terms and conditions in euro-denominated securities financing and over-the-counter derivatives markets based on information from the SESFOD survey”, Financial Stability Review, ECB, November 2018 and “Interconnectedness of derivatives markets and money market funds through insurance corporations and pension funds”, Financial Stability Review, ECB, November 2020.

6. See Euro area bank lending survey, ECB.

7. See ECB surveys, ECB.

8. The Bank of Canada, the Bank of England and the Federal Reserve System conduct similar surveys but only the Federal Reserve publishes aggregated results. See Senior Credit Officer Opinion Survey on Dealer Financing Terms.

9. See Committee on the Global Financial System, “The role of margin requirements and haircuts in procyclicality”, CGFS Papers, No 36, BIS, March 2010.

10. Data collection under EMIR started in 2012, MMSR in 2016 and SFTR in 2020.

11. See Financial Stability Review, ECB, May 2013, op. cit.

12. The standard survey template includes 342 questions which are broadly similar to those asked in surveys by other central banks, enabling a comparison among jurisdictions (see Box 2).

13. Additionally, the first and last survey round of the year includes “special questions” regarding long-term trends and market making. The survey may also include ad hoc special questions such as those asked in June 2020 regarding financing conditions at the outset of the pandemic or in March 2022 regarding energy derivatives.

14. See also the SESFOD guidelines, ECB, 2016, or Financial Stability Review, ECB, May 2013, op. cit.

15. Using the example above, tightened considerably is assigned a numerical score of +2, tightened somewhat +1, remained basically unchanged 0, eased somewhat -1, and eased considerably -2.

16. See the feature entitled “Key linkages between banks and the non-bank financial sector”, Financial Stability Review, ECB, May 2023.

17. See Committee on the Global Financial System, “The role of margin requirements and haircuts in procyclicality”, CGFS Papers, No 36, BIS, March 2010.

18. The fact that European hedge funds assets only represent a fraction of US hedge funds does not change when accounting for total assets of the UK hedge fund sector. Hedge funds based in the United Kingdom also engage in financial transactions or in markets falling within the scope of SESFOD. In particular non-euro area SESFOD participants reflect developments in these transactions in their responses.