Challenges and opportunities facing corporate treasurers in the repo market
Is the repo market making sufficient changes from its traditional interbank-led processes and practices to encourage greater participation from non-bank entities?
According to buy-side treasury and investment professionals speaking at a dedicated session during the recent Euroclear Collateral Conference in Brussels, good progress has been made, but more standardisation and simplicity would be very welcome.
The evolution of the repo market
Wider participation in the repo market has been a rising priority for the last five years. Volumes have stagnated if not declined since the financial crisis and many fear that the combined effect of ongoing regulatory reforms will drain liquidity further, with knock-on implications for fixed-income markets effectively funded by repo activity.
The latest semi-annual survey by the European Repo and Collateral Council (ERCC) of the International Capital Market Association found that the total value of repo contracts outstanding at participating institutions fell 4.1% in June 2016 from the previous survey and 4.2% year on year.
While the ERCC points out that many larger banks are increasing their repo books, the council is deeply concerned about future developments, reflected in its ‘Perspectives from the eye of the storm’ report of November 2015, which outlined the cumulative regulatory pressures that are regatively effecting the repo market’s ability to function effectively.
Meeting demand from the sell-side
In this context, sell-side market participants are keen to broaden their range of counterparties, partly to bolster liquidity, but also because of the low capital charges under Basel III for cash holdings from non-financial firms. From a buy-side perspective, as outlined by session moderator Magnus Lind, founder of Treasury Peer, the appeal of repo as a cash management tool has been growing steadily.
According to a survey of senior corporate treasury executives conducted by Treasury Peer in September, leading drivers for use of repos include a desire to reduce bank credit exposure, a need to replace money market fund investments and the search for yield. The survey also found that 51% of respondents were already using or have plans to use repos, while 63% of those not considering repos expressed low levels of concern about bank bail-in risks, suggesting low interest rates and regulatory reforms as bigger drivers of demand at least in the short term.
Overcoming regulatory and business challenges through repo
For Franz Xaver Augustin, senior financial manager at Siemens Treasury, the decision to participate in the repo market came down to a relatively simple return-oninvestment analysis. “We see repo as an alternative to bank deposits and commercial paper. We’re not willing to pay a premium for collateralisation as we have sufficient counter-party limit available,” he said.
The advent of low and indeed negative interest rates since the financial crisis has posed a number of challenges for corporate treasurers. On the one hand, the interest-rate environment reflects in part a low-growth economic outlook which deters or at least delays investment by corporates, giving treasurers more cash to manage. On the other, negative rates make bank deposits in affected currencies costly, as opposed to merely unattractive, while regulatory reforms are decreasing the appeal of money market funds and commercial paper.
Security versus yield
When asked to nominate their preferred strategy for mitigating negative interest rates, 28% of session attendees opted for issuing dividends and/or paying down debt, while 25% cited use of repos for yield arbitrage. Other less popular options included accepting greater credit risk in pursuit of yield and extending terms for cash deposits.
Jonathan Atack, until recently director of treasury and investor relations at AkzoNobel, welcomed the polling result as being in keeping with prudent, lean balance sheet management, noting also that security and liquidity should always be prioritised over yield. “Treasurers have to be confident that the cash is coming back. Yield is a bonus. I would sacrifice yield for security every time,” said Atack.
Overall, panellists contrasted the prospect of having less cash returned when deposited at banks in negative interest – rate jurisdictions with the security of high-grade liquid assets offered as collateral by repo market participants, in addition to higher yields.
How market infrastructure can help the transition into the repo market
Receipt of collateral, typically in the form of AAA-rated government is – as was acknowledged by Bert Heirbaut, group treasury manager at the IHG Hotels Group – an unfamiliar exercise for nonbanks venturing into the repo market.
Nevertheless, panellists generally expressed comfort with the protection and flexibility offered by transacting repo and managing collateral via tri-party agents (TPA), as well as a willingness to travel along the credit curve. “Corporate and non-investment grade
collateral can be considered as well, because the primary counterparty risk is against the bank, not the bonds held as collateral. Moreover, you can applyhaircuts to reduce the risk,” explained Wouter Ligteringen, manager of treasury operations at Dutch telecom operator KPN.
Ligteringen also noted that TPA-facilitated repo market participation had enabled KPN to widen its range of counterparts, while Caroline Keegan Andersen, senior portfolio manager at ATP, the Danish pension and investments provider, confirmed that collateral substitution was a relatively automated and straightforward process. “It is easy to suspend a particular ISIN on a day to day basis, longer-term inclusion or exclusion requires a more formal agreement,” added Heirbaut.
As noted above, the repo market has largely served to meet banks’ short-term funding needs, developing procedures reflecting this heritage, which can be challenging for non-bank counterparts. Bilateral deals are governed by Global Master Repurchase Agreements (GMRA), for example, which can take many months to negotiate for non-banks, as observed by Franz Xaver Augustin, senior financial manager at Siemens Treasury.
Attempts have been made to standardise documentation, such as Repo Access, which enables buy-side users to enter into triparty repo transactions via a single agreement with Euroclear, which in turn enters into GMRA contracts with cash borrowers. Nevertheless, IHG’s Heirbaut entreated more banks to sign up to the initiative to offer non-banks a wider range of counterparties.
Corporate treasurers and repo-trying to predict the future
If the repo market is addressing the treasurer’s holy trinity – security, liquidity and yield – while increasingly offering greater flexibility and simplicity in its processes, will we see further growth in buy-side participation?
Treasury Peer’s survey found that fewer treasury executives see ‘extensive legal contracts’ and ‘cumbersome implementation processes’ as a barrier to using repos than in 2013. Meanwhile, two-thirds expect their firms to increase cash holdings, suggesting a continued ready supply.
Nevertheless, the ongoing regulatory reforms that are impacting the sell-side are also a concern to buy-side participants in the repo market. When polled during the session, 52% of attendees agreed that proposed regulatory changes, including the EU capital requirements regulation and directive (which effectively implements Basel III in Europe), would negatively affect corporate participation in the repo market (28% disagreed; 29% were unsure).
“We have to manage bank relationships very carefully in the current environment, as banks face a variety of regulatory issues
depending on their particular model and jurisdiction. But we see pockets of opportunity too,” said Keegan Andersen at ATP.
Corporate treasurers share their experience of using repo
Prompted by Lind, panellists said they had ‘no regrets’ about entering the repo market, and expected to continue their present participation alongside a wider range of buy-side counterparts.
Lind suggested this process might be accelerated by a more pro-active approach by banks, pointing out that almost half of Treasury Peer survey respondents had alighted on the repo market following their own research rather than a recommendation or sales call.
As indicated by Siemen’s Augustin, the upside for buy- and sell-side is becoming increasingly evident. “With the caveat that collateral brings only additional not unlimited protection, I can only agree that the repo market offers corporates more opportunity to widen their investment universe,” he said.