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Tri-Party Repos: Minimising Risk, Maximising Efficiency We look at how treasurers can use tri-party repos to be very precise in meeting their risk and liquidity objectives, whilst achieving a high level of straight-through processing.

Tri-Party Repos: Minimising Risk, Maximising Efficiency

by Steve Lethaby, Senior Sales Manager,  Global Securities Financing Sales and Relationship Management – UK, Ireland and South Africa, Clearstream

In my most recent article for TMI (‘A Value Added Approach to Corporate Cash Investment’) I outlined some of the reasons why treasurers are expanding their investment horizons into tri-party repos, and the characteristics of these instruments that make them attractive. This article looks at how treasurers can use tri-party repos to be very precise in meeting their risk and liquidity objectives, whilst achieving a high level of straight-through processing.

The investment context

Corporate treasury is typically characterised by conservative cash investment mandates, prioritising security and liquidity over yield. These priorities are starting to level up, with a greater focus on yield given the extended period of low interest rates, but security and liquidity remain as important as ever. As a result, cash and cash equivalent instruments, particularly deposits and to some extent money market funds (MMFs), have dominated corporate cash investment portfolios, together with instruments such as certificates of deposit (CDs) and commercial paper (CP) amongst those with larger cash balances.

With a range of market, regulatory and internal factors now prompting treasurers to rethink their choice of investment solutions, as discussed in my previous article, investing in tri-party repurchase agreements or repos can be a highly effective means of meeting investment objectives. Banks too will be increasingly motivated to offer tri-party repos given the changing market and regulatory environment, while Target T2-Securities (T2S), the new European securities settlement engine, is harmonising market processes across major European markets, providing both the buy side and the sell side with a more consistent experience.

Tri-party repos in brief

A tri-party repo (or reverse repo from the perspective of the corporate investor) is a secured form of money market instrument in which one counterparty sells securities or other assets to another with the agreement to sell them back on a pre-agreed date. These securities or assets act as collateral in the event of counterparty failure, providing far greater risk protection than most investment instruments, which are typically unsecured. As most assets are subject to changes in pricing, the value of this collateral can be affected, so the use of ‘haircuts’ (margins) adds additional protection against changes in asset prices, usually assessed in percentage terms. For example, a haircut of 2% may be added to the market value of an asset, but this can differ according to asset class.

The maturity of a repo is variable, usually up to 90 days, with the interest rate (or repo) rate calculated based on the yield of the underlying security between the sale and repurchase date. From an accounting perspective, short-term tri-party repos are considered as cash equivalent instruments, and therefore there are no additional back-office complications to consider.

Flexibility and versatility

Tri-party repos offer considerable flexibility for investors, and often far more than other instruments. From a liquidity perspective, treasurers can select a maturity date, as they would a deposit. From a security point of view, they can choose an asset profile that meets their credit policy, whilst taking advantage of higher returns that may be available on longer-term securities compared with deposits and MMFs. Many treasurers have focused on higher grade government bonds as repo collateral, which has the advantage of simplicity. However, demand is very high for these assets, notably from banks to meet their liquidity coverage ratio and as collateral for over-the-counter (OTC) derivatives with clearing houses. With a lot of demand for these instruments, the return is inevitably depressed, and availability is reduced. Consequently, other types of asset are becoming more attractive, such as investment grade corporate debt, emerging market assets and some types of fund.

The ability to tailor credit criteria according to a company’s risk appetite, which gives the ability to attract a higher yield, is becoming a compelling proposition for corporate treasurers. As with any secured investment, the collateral itself is only important if the counterparty defaults, so treasurers perform the same due diligence on repo counterparties as they would for any other investment product. Given the nature of the instrument, however, they may be in a position to connect with a wider range of counterparties, again providing greater flexibility.

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