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Catching the next wave of OTC derivative margining

Catching the next wave of OTC derivative margining

A divergence in priorities and circumstances across regions means that corporate treasurers in Asia have not yet embraced the repo market with the same enthusiasm as their European and US-based colleagues.

But they are nevertheless very alert to the potential need to widen their cash investment options, according to speakers on a panel discussion at Euroclear’s Asia Collateral Conference 2016, entitled ‘Corporate Treasury: the integration of new market participants into the world of repo’.

The session asked three Hong Kong-based corporate treasurers and three bankers to chart the likely course for greater corporate participation in the repo markets of Asia, starting with the motivations for extending cash investment policies beyond traditional instruments, but touching also on the operational implications, which are evolving as service providers respond to latent demand.

Asian corporate treasurers still feel safe

Universally, treasurers seek capital preservation, liquidity and yield from their short-term investment options, typically in that order.

But unlike their western counterparts, Asian treasurers are largely content with outcomes across these three criteria from placing short-term deposits with relationship banks, giving them less incentive to explore the unfamiliar repo market.

Much of this difference across regions can be explained with reference to the aftermath of the financial crisis.

Repo transactions might well offer the treasurer a greater prospect of capital preservation, by virtue of the high-quality collateral delivered by counterparts in return for cash, versus unsecured deposits.

But, shielded from the harshest impacts of the financial crisis, Asia’s corporate treasurers perceive their credit exposure to banking counterparties as less of a clear and present danger than peers in Europe and US, who have seen some relationship banks collapse with others buffeted by a decade-long rollercoaster of reforms, scandals and fines, which has negatively impacted reputations and credit ratings.

Panellists agreed that, not only can bank deposits be highly tailored to needs, but they are also very important in the context of the broader banking relationship.

More importantly, they cannot be regarded as truly unsecured if firms are placing deposits with banks that are providing credit support.

Yield is a key factor

From a liquidity perspective, Asia’s treasurers generally have little reason to desert cash deposits due to a healthy current appetite by banks across the maturity spectrum (all treasurers on the panel had a preference for short-term deposits, with two net borrowers), meaning the return or rollover of cash at the end of a term could barely be simpler.

With the repo market offering similar tenors to bank deposits, subject to supply and demand, liquidity is a much less defining factor than yield.

Unlike North American and European corporates, Asian firms (ex-Japan), have not faced a sustained period of low-to-zero-to-negative interest rates. Indeed, deposit rates are generally attractive, with some markets experiencing significant competition.

European corporates face a different landscape

Continued low economic growth and uncertain prospects in developed western economies have influenced both the unappealing rates available to local corporates and the record levels of corporate cash holdings, as reflected in World Bank data cited by session moderator Allen Leung, treasurer, COFCO (Hong Kong) and Vice President of the International Association of CFOs and Corporate Treasurers (China).

With large cash reserves burning holes in their pockets, it is unsurprising that North American and European corporates have been looking for alternatives to bank deposits and money market funds (the latter rendered less attractive by post-crisis reforms in a number of jurisdictions both east and west), thus responding positively to entreaties by banks to participate in the repo markets.

Alongside the regional differences in the weight of push factors nudging treasurers to consider repo, a major pull factor – the needs of existing market participants – is also subject to local variation.

Repo market activity by many banks has declined in recent years, largely thanks to higher balance sheet costs resulting from Basel III.

But the impact has been felt most strongly in Europe and the US, where the repo markets are dominated by the systemically-important banks most affected by post-crisis reforms, prompting a range of efforts to bolster repo market activity, seen as critical to day-to-day bank funding operations.

Under the new rules, corporate participation is a priority.

“In effect, Basel III’s Net Stable Funding Ratio makes cash raised from non-financial corporates via less than six-month repo preferable to cash from financial institutions of the same tenor,” explained Yanny Leung, Vice President, Bank Resource Management, Morgan Stanley.

Not only are banks showing a strong appetite for offering high-quality liquid assets as collateral to secure corporate cash, but – in league with service providers and market operators – they are revisiting market practices to make a previously bank-led market more user-friendly to a wider range of participants.

Diversifying risk

Although largely content with bank deposits, Asia’s corporate treasurers are highly sensitive to the risks of relying too heavily on one instrument to fill their cash investment needs.

Yields can rise and fall, regulations can change incentives and appetites overnight, unexpected market events can impact systemic stability, panellists acknowledged.

“Ten years ago, extreme market stresses prevented corporates from placing deposits and they may face similar challenges in the future,” warned Jack Cheung, CEO of Hong Kong’s Treasury Markets Association, and a former banker.

Whether attracted by the prospect of higher returns or the need to diversify, treasurers must offset potential gains against the costs of entering and maintaining participation in an unfamiliar market.

Logistical challenges

Panellists identified three key logistical barriers to Asian corporates entering into the repo markets: documentation, operational set-up and board approval.

While all agreed that the various legal agreements governing repo transactions can be complex and long to negotiate, Leung pointed out that initiatives such as Euroclear’s RepoAccess (which enables non-bank participants to transact with multiple counterparts under a common agreement) were already simplifying and shortening the onboarding process.

Similarly, the operational implications of entering the repo market are being addressed.

It has long been practice for new repo participants to trade via a Tri-Party Agent (TPA) to effectively outsource day-to-day collateral management operations and reporting.

In recent years, the capabilities of TPAs have evolved steadily to further simplify the management of market-specific workflows, such as substitutions.

Dennis Zhou, Head of Investment, CGNPC Huasheng Investment, noted that recently-established repo markets – such as China’s exchange-traded market – offered standardised collateral baskets and high levels of automation. “Screen-based trading and standardisation are preferable to daily negotiations with counterparties on collateral, from a corporate perspective,” he said.

Prompted partly by the results of an audience poll, panellists also noted that treasurers in the Asian market may need support from banks and service providers to win board-level approval to widen existing investment policies to include repo market.

A panellist from one of a large custodian bank remarked that it was important for banks to be able to explain the advantages offered by repo in a way that corporate treasurers can then transfer the information to their boards.

For the time being, Asian corporates are taking a more cautious approach to the repo market than western counterparts, due to a less urgent need to diversify cash investment options.

“Trends in Europe and the US have driven corporates toward the repo market, but the Asian market is different, not least because of higher rates,” said Kenneth Ng, Corporate Treasurer at DFS Group.

“Nevertheless, repo could help us diversify.” When Asian corporates are ready to explore the repo markets, the ongoing changes to market practice currently should ensure an increasingly smooth on-boarding process.

 

“In effect, Basel III’s NSFR makes cash raised from non-financial corporates preferable to cash from financial institutions”   Yanny Leung, Morgan Stanley

“Trends in Europe and the US have driven corporates toward the repo market, but the Asian market is different, not least because of higher rates,”   Kenneth Ng, DFS Group

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