Road to rate-friendly repos becomes smoother for corporates after Fed move.
Rates are rising. Should corporates be thinking more seriously about repurchase agreements (repos)?
There are plenty of factors that should make repos attractive to multinational corporations (MNCs). They are relatively liquid, short-term investments that are fully collateralized, even over-collateralized to cover unwinding the collateral if necessary, and they often pay a bit of a premium over alternatives such as (MMFs) market funds or commercial paper (CP). Those benefits have always been there, and yet corporate treasury executives show little interest in the investment product, whether at recent NeuGroup meetings when the issue has been raised or in actual practice.
MNCs have displayed somewhat more enthusiasm toward the European repo market, where clearing and settlement houses Euroclear and Clearstream have aggressively sought corporate clients in recent years, in part by facilitating the documentation and legal-agreement process. Euroclear, for example, counts Microsoft and AstraZeneca among its corporate clients, which now total north of 60. Clearstream says its corporate repo clients have nearly doubled over the last year, and the trade volume they contribute has jumped by 50%, to 23% of the total.
Those numbers represent significant improvements. However, given the cash corporates have on their balance sheets and the historically low, even negative rates of short-term investments across the continent, corporate participation there is far from robust—except when compared to activity in the U.S.
BNY Mellon and J.P. Morgan have long been the tri-party repo clearing and settlement agents in the U.S., with former conducting the vast majority of the business today. A year ago, John Vinci, a managing director at BNY Mellon, told iTreasurer that the bank had yet to see a significant increase in corporates participating directly in the tri-party repo market. When approached this year, he declined to be interviewed about any developments since, suggesting little had changed.
But perhaps change is coming soon, because much has changed for corporates. New regulations going into effect next fall will make MMFs less attractive while other regulations are prompting many of the large banks to reduce their corporate deposits. And now the Federal Reserve anticipates raising rates gradually—perhaps not so gradually if inflation surprises—and repos can provide a distinct advantage over alternatives such as MMFs in a rising rate environment.
“Repos and MMFs will be very competitive in terms of rates, but you’ll find repos react more quickly,” said James Tabacchi, president and CEO of South Street Securities, a broker-dealer that focuses specifically on the repo market and intermediates trades between repo borrowers and lenders using its own capital. In fact, repo lenders saw rates for repo deposits jump to between 35 bps and 45 bps last week, when the Fed approved a rate increase, from 12 bps to 20 bps a few weeks before, Mr. Tabacchi said.
Another factor that should make repos increasingly attractive is more sophisticated technology. Repo trades have traditionally been transacted over the phone. Tradeweb, an electronic trading platform for fixed-income and rate products, has enabled repo trading since 2005, racking up $150 trillion in trade volume since then. It has a significant number of corporate customers that use the platform to invest directly in fixed-income products, but relatively few engaging in repo transactions.
“Traditionally, we have not had a lot of corporates focus their trading on repos,” said Jon Williams, head of U.S> institutional market operations at Tradeweb. “That market constituency hasn’t yet evolved its practices very far away from what they’ve done for decades.
Should their interest in repo pick up, Williams added, accessing the market through Tradeweb is relatively easy, once they put in place legal agreements with the tri-party agent and their counterparties, which in many cases will be their relationship banks. Tradeweb will help them install the software to trade over the platform, and it will integrate it into a corporate’s treasury back-end technology.
“If a corporate has its own internal cash or order management system that defines its needs or instructs the treasurer or whoever is trading what needs to be done, those instructions can be electronically sent to Tradeweb and staged in our system,” Williams said. “The treasury executive can initiate the trade, get the electronic response back in seconds, agree to the terms of the trade, and once that happens all the details will flow downstream to their system, the counterparty’s and the tri-party’s.”
At least one major vendor catering to corporate treasuries, International Cash Distributors (ICD), appears to see corporate interest in repos picking up. It announced an agreement with Tradeweb in October to provide access to the electronic trading platform through its investment portal, eliminating the need to connect directly to Tradeweb and take up additional desktop real estate. Over Tradeweb, ICD client will be able to trade not only repos but time deposits, commercial paper, CDs, U.S. agency discount notes, U.S. Treasuries and U.S. agency securities.
South Street makes the process easier in at least one important way. Clients only sign one agreement, with South Street, as the trade intermediary.
“We take the cash and lock it up at BNY Mellon as custodian, and lenders would have access to the collateral if something were to happen to their counterparty or South Street,” Mr. Tabacchi said.
Institutions currently lending to South Street include money market accounts, state and local municipalities, Federal Home Loan Banks and exchanges, as well as the Fixed Income Clearing Corporation arm of the Depository Trust Corporation. Borrowers are typically real estate investment trusts, asset managers with portfolios of securities, such as hedge funds, and regional banks and brokers.
In terms of corporates, “We’re seeing some more corporates, more like a ripple than a wave,” Mr. Tabacchi said, adding that South Street only offers repos collateralized by Treasuries, agency debentures and agency mortgage securities.
Repos do take some additional expertise, but not much more.
“If you’re familiar with rates in CP, you’ll have enough of a knowledge base to be familiar with the rate for repo,” Mr. Tabacchi said. “It’s in the money market section of the curve; relatively high quality and low risk.”