There was a time when the repo market was the preserve of banks and central banks, which used it for interbank securitised borrowing and lending. But since the global financial crisis struck, repos have entered the mainstream and today they are increasingly used by corporates as an investment product. Their appeal is simple: they deliver yields that are as good as – if not better than – unsecured bank deposits, while offering the additional benefits of security, flexibility and control.
A repurchase agreement or ‘repo’ is a sale of a security by a bank together with an agreement for the bank to buy the security back at a later, predetermined date – perhaps as soon as the following day. The repurchase price will be greater than the original sale price, with the difference between the two effectively representing interest – usually referred to as the ‘repo rate’.
The counterparty that buys the security (the corporate) is the cash provider, while the seller (the bank) is the cash taker. Among the types of security that can be used as collateral are all types of fixed-income securities, including government and corporate bonds, commercial papers and certificates of deposit, as well as equities and money market or mutual funds.
With a tri-party repo, there is a third party involved in the trade. This is a collateral management agent, which is an independent intermediary that is appointed to handle the administrative tasks associated with the repo. The two trading parties will agree the details of the repo, including the currency, principal amount, interest rate, term and collateral set (or ‘basket’), and pass these on to the tri-party agent for matching and confirmation.
Once these terms have matched, the trade will be presented for clearing (or opening) on the value date. The cash will move through the segregated tri-party collateral account of the cash provider and be paid to the cash taker, while the securities will simultaneously move into the tri-party collateral account of the cash provider. Put in simple terms, a tri-party repo is essentially a bank deposit that is backed by assets that are independently held and managed.
The collateral management agent will then monitor the trade on an ongoing basis, focusing on issues such as margin calls (if the value of the collateral moves up or down, securities may need to be brought out of or into the account), credit ratings and substitution of securities. When the trade closes, the tri-party agent will ensure that the cash and collateral are duly returned to their rightful owners, with the cash provider receiving its accrued interest as appropriate.
Put in simple terms, a tri-party repo is essentially a bank deposit that is backed by assets that are independently held and managed
As an investment product, tri-party repos offer many benefits to corporates:
Note: Reuse of collateral is only possible within the tri-party system itself, since the tri-party agent always needs to guarantee the right of substitution for the original collateral giver.
Thanks to the Basel III banking standard on capital adequacy and market liquidity risk, banks increasingly want to take cash from their corporate clients on a secured, rather than an unsecured, basis, especially in the long term. That’s because they see it as a way to get balance-sheet liquidity. The capital and liquidity coverage ratios set by Basel III also mean that banks are trying to squeeze as much economic value as possible out of the collateral that they hold – in other words, they want to make sure they have the right collateral, in the right place, at the right time.
Meanwhile, corporates like being able to ring-fence their cash against collateral and have it managed by a third-party administrator rather than entrust it to their bank on an unsecured basis. So it is not surprising that the tri-party repo market is continuing to grow in popularity. Without doubt, repos are here to stay and they will be used more and more in the years to come.
A haircut is the amount of over-collateralisation that a treasurer will demand with a repo in order to get a buffer should they ever need to liquidate the collateral at market value. If the collateral is a top-quality asset such as sovereign debt, then the haircut is likely to be minimal, but it will be greater for a more volatile asset that may drop in value or become less liquid just at the time it needs to be sold. Some treasurers will look at the likely five-day volatility of an asset and base their haircut on that.
For more on investing in repos, see www.clearstream.com and the ACT webinar at www.treasurers.org/investinginrepos
Steve Lethaby is vice president, global securities financing for the UK, Ireland and South Africa, at Clearstream
