By John Hintze
New regulations and better yields fostering corporate demand.
Corporations with cash to invest but mindful of counterparty risk and the impact of unfolding regulations are continuing their slow, steady march into the triparty repurchase agreement (repo) market, even though yields there have dropped from their highs.
Yields of triparty repos, which are administered by a custodian bank or other third party, have been much better than those offered in other assets. The number of corporates in BNY Mellon’s repo program has grown to the low double digits over the last few years, according to John Vinci, a managing director at the New York-based bank who heads up product management and strategy for its broker-dealer services.
Across the Atlantic, however, Euroclear and Clearstream, which support the bulk of triparty repo activity in Europe, have seen even greater corporate participation—estimated at as much as 15 percent of their repo activity.
Despite the growth, the arrival of corporates has been gradual. That may be because many are waiting to see how the impact of various regulatory initiatives shakes out. In the US, for example, proposed money-market fund regulation may or may not lessen that market’s attractiveness compared to triparty repos, and the outcome of the Federal Reserve Bank of New York’s triparty repo infrastructure reform, expected to be completed by year end, remains uncertain.
Long term, however, several factors point to corporates becoming much more
significant participants in the repo market. “Emerging factors are prompting dealers to increasingly consider corporates as counterparties,” Mr. Vinci said.
a “pipeline of corporates”
Corporate participation in the triparty repo market supported by Euroclear S.A. rose to 10 percent of its entire activity following the demise of Lehman Brothers and the ensuing global financial crisis. “Today that figure is still around 10 percent, but what’s impressive is the pipeline of corporates lined up to start using Euroclear services for repos,” said Olivier de Schaetzen, director at Euroclear. He added that the largest corporates such as General Electric and companies in sectors including airlines and chemicals led the pack, and now midsize companies are following suit.
Capital Advisors Group allows repos in separately managed accounts for its corporate customers. Lance Pan, director of investment research and strategy at the Newton, MA-based investment advisor, said corporate interest in the product picked up in 2011, when market dynamics pushed repo yields up to 20 basis points or more, exceeding what was available in the MMF market.
In 2013, yields fell below 10 basis points, and the demand for high-quality collateral stemming from new regulations such as Basel III and anticipated collateral requirements for cleared and uncleared swaps, will likely continue pressuring repo yields. On the other hand, the Federal Reserve’s easing of its Quantitative Easing bond-buying program and active bond issuance by the US Treasury are making Treasury bonds more available, putting upward pressure on yields. Despite the uncertainty of future returns, however, the diversification repos offer has continued to draw corporates to the market. “More of our clients used repos in 2013 than the year before,” Mr. Pan said. “Now it’s more of a diversification play than a yield play.”
More companies using repos in 2013 than the year before.
— Lance Pan, Capital Advisors
The pace of corporates entering the triparty repo market may also pick up as demand for their cash increases. Mr. Vinci said one reason corporates are finding an increasingly warm welcome is that traditional cash providers in the triparty repo market have mostly been buy-side asset managers, mutual funds and money market funds, and they’ve sought to engage in very short-term trades, some not more than a week. But dealers looking for financing—typically the other side of triparty repo transactions—are now seeking to extend the duration of their trading books and better stagger maturities of triparty trades so smaller amounts mature day to day, reducing the risk of being unable to roll over a large chunk of their books.
“If traditional repo counterparties determine that they prefer to do only shorter-term trades, then the dealer is going to look outside that traditional group of investors, and that’s where corporates come into this,” Mr. Vinci said.
Corporates’ search for longer-term investments also fits nicely with banks’ need for longer-term financing that stems from new regulations requiring more predictable financing sources that are less prone to runs. “There will be more demand for cash coming from the corporate world because it’s stable term funding, which is exactly what banks require from a regulatory perspective,” Mr. de Schaetzen said.
Corporate Share Not as Small as Suspected
BNY Mellon typically manages between $1.4 trillion and $1.5 trillion in triparty repo agreements daily, and corporates make up only a small percentage of that. John Vinci, a managing director at BNY Mellon, says that small percentage is deceiving, however, because corporates are significantly involved in triparty repos indirectly, by investing mutual funds, money market funds and other asset managers active in the triparty repo market.
In addition, swap market participants are expected to turn to the repo market to exchange securities on their books that are ineligible as collateral for the high quality eligible variety. The huge amount of new collateral that is anticipated to be required—upwards of $2 trillion, according to the Tabb Group—is fanning fears that the current repo market’s liquidity will be insufficient, and new sources of cash and collateral, such as that provided by corporates, will be necessary.
Another factor favoring corporates participating as triparty repo investors is the rating-agency requirement for MMFs to roll repos with dealers whose debt is rated at least investment grade. That excludes many less-than-first-tier dealers, who instead can look to corporates, for which there’s no such ratings requirement.
“Many counterparties won’t care whether the broker-dealer is rated as long as the repos are backed by government collateral, but the rating-agency requirement on MMFs limits the extent to which those funds can do repos with unrated entities,” says Lance Pan, director of investment research at Capital Advisors Group. “This opens the doors for corporates to participate in repos.”
Tough entry but worth it.
The triparty repo market is initially arduous to enter but relatively straightforward once legal agreements are signed with custodians and dealers—a requirement for investors accessing the market independently as well as through separate accounts. Mr. Pan said customers of Capital Advisors’ separate account may not be the largest multinationals, but they must have sizable pools of idle cash they want to put to use—balances of at least $10 million and generally higher.
Mr. Vinci said such balances are relatively small, at least compared to the types of transactions asset managers are doing with dealers to adjust inventories. Nevertheless, triparty repos aren’t difficult to settle from the dealers’ perspective, since the custodian simply transfers the eligible collateral it already has in its custody.