Olivier de Schaetzen, Director, Euroclear:

During the financial crisis corporates were exposed to high levels of risk from the banking sector which they perhaps were not fully aware of. Since then, corporates have been actively looking to reduce their exposures to banking/deposit risks, using novel methods to invest their cash balances. One such method which corporates have adopted that has become increasingly popular, especially with multinationals with large cash pools, is repo agreements. A repo agreement allows a corporate to move from the unsecured to the secured world when depositing cash with counterparties; through receiving securities collateral which mitigates the credit risk of the counterparty. This collateral can be liquidated by the cash giver in the event that the counterparty is unable to repay the loan.

For a corporate, the beauty of a repo agreement is that the ‘risk-and-return’ equation on their investment can be adjusted and set to match their internal investment policy. This is due to the corporates’ ability to decide on the spectrum of assets, their quality and also what percentage of a haircut is required on lesser-quality collateral. For example, if a corporate wants to take minimum risk then they can request high-quality collateral, such as German Bunds. Conversely, if the corporate is looking to generate greater yield, it can broaden its universe of eligible collateral to include corporate bonds or equities.

Repos can also offer corporates operational benefits, particularly if they engage in triparty repos where a dedicated triparty agent like Euroclear Bank manages all of the operational burdens throughout the lifecycle of the repo agreement including margin management and collateral substitutions. Currently many corporates spread their deposits across many different banking partners as a way to mitigate the risk they pose. However, if a corporate enters the repo market and begins to deposit their cash on a secured basis, it can dramatically reduce the number of counterparties it has, reducing the number of relationship and the respective transactions. This can reduce operational work and also offer improved account management and oversight.

In addition to day-to-day cash pool deposits, the repo market is also used to support strategic corporate actions. For example, corporates who have acquired a large amount of cash to fund an investment or from the selling of business units are able to use the repo market as a way to deposit this cash on a secured basis. In doing so the corporate has the peace of mind that their money is secure while they wait to make the investment or decide how to reinvest the money in the event of a disposal.

Another benefit of the repo market, which has seen its popularity increase, is that corporates can use the collateral they receive from their reverse repo activity to create a pool of quality assets that can be tapped in order to cover their obligations for derivatives.

While the repo market can offer corporates many benefits, there are still a number of barriers which prevent wider entry. One such barrier is the challenge presented by the Global Master Repurchase Agreement (GMRA). While this agreement is referred to as an industry standard, lengthy negotiation with each individual counterparty can be needed in order to iron out the specifics within the agreement. Corporates with little knowledge of the secured financing world, legal capacity or expertise in the repo market can often find the process time consuming and off-putting. We are currently looking at the different ways in which the initiation process can be made simpler for corporates through a ‘true’ and simple industry standard derived from the GMRA in order to facilitate the entry of corporates into the repo market.

Another challenge for corporates entering the repo market is the levels of cash needed to participate. Because the banks are dealing with large amounts of cash on their side of the equation, corporates need to match these levels in order to become active trading counterparties. This is the primary reason why large multinationals are the most active corporates in the market and why it is often perceived as being closed off to smaller companies.

Stephen Beill, Director – Securities Finance, Citi:

Since the financial crisis we have seen a large growth in the use of repurchase agreements by corporates. Before the crisis many corporates were placing money with banks on an unsecured basis. However, the rating downgrades which many banks suffered during the crisis saw a reduction in the amount which corporates could place on an unsecured basis, due to their investment policies. Corporates therefore began looking towards alternative investments, including repo agreements; more precisely reverse repo agreements, as a method through which they could place cash with a bank on a secured basis.

A reverse repo is a secured investment, where the corporate places cash with a counterparty who in return puts up collateral to at least the value of the cash, thereby providing two layers of protection: first and foremost to the counterpart; however should the counterpart default, the corporate takes ownership of the collateral which they can liquidate to retrieve cash back. The whole process is usually managed by a tri-party who ensures the collateral meets the criteria agreed at the outset of the trade and will margin daily to ensure the value of the collateral always meets the value of the cash plus any haircut agreed.

The return which corporates can achieve from a reverse-repo trade also adds to their popularity. This is driven by the type of collateral a corporate is prepared to take and the term of the trade. Surprisingly, returns to the corporate in investing their cash in a secured reverse repo trade can often exceed the return of an unsecured trade. This is because a reverse repo is essentially funding a bank’s assets and for the bank this can be cheaper than seeking internal funding. Banks therefore may be willing to pay a premium for this cash, particularly if the corporate is prepared to enter into a termed trade. This often leaves corporates thinking that a reverse repo is “too good to be true”, when really this is just another beauty of the product.

Despite all the positives which a reverse repo can offer to a corporate there can be significant barriers to entry which historically have proved off-putting. The most prominent of these is GMRA. Due to GMRA the corporate and the counterparty are faced with a lot of work and therefore the counterparty often is only prepared to enter into an agreement with a corporate if the terms of the likely trade meet certain criteria, such as adequate size and term. Repos have therefore historically been an investment tool only used by larger corporates with a significant amount of surplus cash.

Ultimately, I see corporate participation in the repo market continuing on its upward trajectory. The current uncertainty surrounding the Money Market Fund (MMF) industry reforms will be a driver, as will products which provide the corporate with quick and easy access to a very attractive investment alternative.

Richard Comotto, Senior Visiting Fellow, ICMA Centre at the University of Reading:

There is little or no quantitative data about corporate involvement in the repo market but there is talk about more corporates turning to repo in order to reduce their unsecured exposure to banks and other financial institutions. Such non-financial institutions would be most likely to access the repo market using tri-party services to relieve them of the necessity for setting up bespoke clearing, settlement and collateral management infrastructures.

There are also an increasing number of electronic repo B2C dealing systems being rolled out to attract both non-bank financial and non-financial investors. A number of banks have offered proprietary bilateral systems for several years to their customers, who can see or request price quotes from the dealer. But there are also more commercial multilateral systems connecting individual customers to panels of competing banks who are signed up to support the system by providing competing price quotes. Typically, a customer makes a request for quotes (RFQ) and banks on the panel respond (without seeing the quotes entered by competitors). The customer accepts the best quote or can negotiate. Traditionally, the main customers were non-bank financials. However, the newest systems incorporate a tri-party back end, which makes them more suited to non-financials.

There is little doubt that the provision of liquidity by traditional financial intermediaries is being made more expensive by a wave of new regulation being imposed on banks, particularly the Basel Leverage Ratio and Net Standing Funding Ratio (NSFR). Leverage ratio exposure must be measured without being offset by collateral. Also exposures cannot be reduced by netting against opposite trades possibly except where this happens through a central clearing counterparty (CCP). The NSFR penalises maturity mismatches between borrowing by banks and on-lending to non-banks, including corporates, by imposing quotas on term funding. Banks have already started to reduce the size of their repo books and there can be little doubt that this will make the repo market more expensive and less liquid as a source of both investing and funding (albeit less disadvantageous than the alternatives). There is much talk of new non-bank intermediaries entering the market to take up the slack but no sign as yet. It is more likely that the disintermediation of banks will have to await new technology which can match non-banks.

The principal legal challenges for corporates are threefold. Firstly, they need to ensure that they have the general capacity and authority to transact repo with their intended counterparties but also the particular type of repos that they plan to employ (eg tri-party repo). Secondly, prospective corporate users need to conduct the legal due diligence required to ensure that the master agreements they sign with their counterparties are legally robust. It needs to be remembered that the providers of tri-party repo services are only agents, so there is a direct legal relationship that needs to be documented between the non-financial user and its bank counterparty. Fortunately, the most widely used model contract, the ICMA’s GMRA, provides a sound and well-tested foundation. Finally, corporate investors should check that, if the worst came to the worst and their counterparty defaulted, they would be allowed to accept the collateral onto their balance sheets before liquidating it (there are operational requirements here as well).