Treasurers proceed with caution
Corporate treasurers are cautious folk. They have to be. Their role is to ensure that a complex, multinational company can fund itself, in any circumstances. Regardless of economic slumps, financial market turmoil or strategic mistakes by the c-suite, the treasurer has to make sure the bills get paid, the acquisition is financed, the expansion into new markets is supported.
According to Peter Matza, the Association of Corporate Treasurers', the professional life of the treasurer is one of trade-offs and compromises. One of the most common questions the treasurer considers is: “What are we funding and what are the risks to our stakeholders?” Matza, a former treasurer and now engagement director at the ACT, said the essence of the job is the “transfer of risk in support of business strategy”.
When considering greater corporate participation in the repo markets, it is therefore no surprise that liquidity and counterparty risk are among the top priorities for treasurers. To be blunt, they don’t want to get into something they can’t get out of. And they do not want to do business with someone who might not be able to honour the deal.
Nevertheless, the case for growing the supply of cash collateral by large corporates to the repo markets is increasingly clear.
On the supply side, many corporates have built up substantial cash holdings as they ride out prolonged macro-economic uncertainty for the right opportunity for expansion or acquisition.
Counterparty risk concerns and negative interest rates are among the reasons they cannot or will not countenance posting more cash in bank deposits.
On the demand side, both banks and asset managers are in greater need of collateral, the latter to support initial margin calls from central counterparts once central clearing of OTC derivatives becomes mandatory in Europe, expected in the second half of 2016. Banks are reviewing their collateral needs too, largely to comply with Basel III, which – perhaps ironically, certainly unfortunately – has also had the effect of limiting their appetite for repo market activity, thereby denting volumes.
As of now, corporates are not a major force in repo. Only 26% of digital poll respondents at the Euroclear Collateral Conference considered corporate cash as critical to the repo market. Corporate treasury professionals have suggested the laws of supply and demand still need a little help to unlock the potential flow of new collateral.
All speakers currently operate repo programmes. All have experienced delays and frustrations in getting these up and running. Some of the problems were caused by market conditions, others by market structure. In both cases, patience was required as the wheels of the corporate’s finance function ground into action.
Corporates already take on many risks in their core business – whether that’s producing cars, running hotels or delivering online entertainment services – so when it comes to taking on new financial risks, due process must be followed. This applies equally to broadening out the quality of acceptable collateral in response to prevailing negative interest rates or approving ounterparties and agreeing to the terms and conditions laid out in a Global Master Repurchase Agreement (GMRA) before establishing a programme.
Indeed, documentation was mentioned regularly in a Euroclear corporate panel, as one of the major impediments to corporate participation in the repo markets. But while legal hurdles were the most frequently cited barrier (31%) by the audience in an accompanying digital poll, it was telling that 61% felt that ‘all of the above’ were preventing corporate treasurers from playing a fuller role in the repo markets.
Recognising that their own internal processes could certainly be improved, there was also a feeling amongst the panellists that sell-side counterparties could be more flexible. The postcrisis world had changed circumstances, but not necessarily attitudes among some banks: more transparency on pricing and more of a relationship approach would help, the corporates agreed.
Already, there is clearly no shortage of innovation in the repo market to support greater corporate participation. Various clearing houses are looking to extend existing inter-bank central clearing mechanisms; banks are developing extendable or ‘evergreen’ contract terms to improve flexibility; triparty agents are enhancing their offerings too (Euroclear, for example, now enables corporates to access multiple counterparties via a single GRMA). All of these are welcomed by the corporate treasury community, but all are regarded as works in progress that require further finessing.
Perhaps there will be no silver bullet, no killer app, just the grinding, persistent, behind-the-scenes work that will eventually bear fruit, by bringing in extra liquidity to match growing needs. The key question perhaps is whether these collective
efforts will come good in time. As well as the looming, albeit regularly delayed, central clearing mandate of the European Market Infrastructure Regulation, Basel III is being rolled out in stages. At the Euroclear Collateral Conference in Brussels, delegates were asked whether they thought cash from corporates could become the main source of collateral by 2018, in light of the negative impact on banks of Basel’s net stable funding ratio. The results – 54% said ‘no’, 23% ‘yes’, 23% ‘don’t know’ – further underline the hard yards the industry may have to undertake collectively to keep maintain the flow of liquidity into the repo market.