Outsourcing key trading and financing functions has taken on a new importance in an era of regulatory change and cost pressures. Repo has withstood change but that is now beginning to shift, and the possibility for agency repo, including bespoke arrangements in trading and operations, is growing. A guest post from Société Générale.
The idea of outsourcing repo activities requires little explanation for market professionals. Buy-side firms faced with reporting under the Securities Financing Transactions Regulation (SFTR) have new costs and operational burdens, and regional banks with small repo desks are in a similar position. Across the industry, an opportunity to concentrate on a firm’s primary strengths while moving away from ancillary functions offers attractive benefits.
But repo is not like other businesses. There is a relationship aspect that includes not just a phone line or electronic messaging system, but also the knowledge that assets can be financed or cash can be invested when balance sheets are scarce. Outsourcing a repo desk entirely could mean losing key pieces of a valuable relationship that offers market intelligence, coordination with collateral management and access to other products. A full outsource may not be for everyone.
Agency repo steps into this unique space by offering a range of possible services, taking its cue from the well-established business of agency securities lending. At Société Générale, we have evaluated how we can best serve our clients who lack the resources or interest to maintain a full repo operation in the face of SFTR and other industry challenges. Done right, agency repo could offer substantial value to clients and allow them to grow their franchises.
Agency repo is a different type of outsourcing
While middle office outsourcing and agency securities lending are well established, and outsourced trading is currently a topic of consideration, repo is a different beast. All four business activities share numerous features but it is worth highlighting their differences to show where repo stands out.
Outsourcing middle office has been a market trend over the last decade and continues to grow fast. In 2017, a survey by vendor FIS found that 12% of the buy-side market outsourced their middle office activities, with another 29% planning to expand outsourcing in the next five years. In 2020, the conversation is about whether middle office outsourcing has reached a tipping point of momentum, and the core question is not whether to outsource but why not?
The benefits are generally acquisition of specialist resources and technology at low cost and a reduced management burden. Advocates of the outsourced middle office model report that they are satisfied, and we have seen few firms from any provider that have rebuilt their internal operations after outsourcing. There is information value in middle office activities, but outsourcers have found that provider reporting meets the majority, if not all, of their needs.
Agency securities lending is the dominant industry model globally. Data from consultancy Finadium show that 95% of securities lending business by volume from the buy-side runs through an agent lender; the remaining 5% is conducted by firms with internal lending desks. While the internal model continues to have adherents in some parts of Europe, and a few US managers are now exploring self-lending with outsourced back office support, most agent lenders run a fully outsourced lending program for their buy-side clients; the business model is typically presented as an all or nothing outsourcing approach.
Securities lending is a relationship business, but there is little information flow between the borrower and the beneficial owner that is impactful on a day to day basis. Multiple vendors offer data services and most agent lenders provide robust reporting on program activity based on a global shared infrastructure for the benefit of multiple clients.
Outsourced trading is growing in interest but is not yet a dominant industry model. While some firms have made the move due to lower costs, infrastructure management and reporting requirements, others believe that an internal trading desk remains an important competitive lever for fund management. There is also the question of if, under MiFID II, the cost of trading could be transferred to the funds as an expense rather than an internal desk paid for by the fund management company. Other factors for consideration include analyzing the quality of service and expertise of the trading desk, along with risk management and execution quality. The information flow of outsourced trading is a substantial consideration, as well as how fast market trends can be transmitted back to portfolio managers for decision making on investments.
Repo is something of a hybrid across these other products, in that there are fixed costs for human resources, infrastructure and regulatory reporting, but there can also be important information flow and relationships that could persuade an institution to keep the function in-house. Repo offers opportunities to fund positions and invest cash, and can inform traders and Treasury managers on important liquidity movements in the market.
When considering repo outsourcing, there is a possible continuum of services between what remains in-house and what can be leveraged externally. This enables a controlled risk framework for internal trading vs. external process management. Repo is closely tied to the process of collateral optimisation; in an age of increased collateral scarcity and uncleared margin rules, it can be critically important to manage repo and collateral together. This becomes more relevant when the repo market is subject to periods of dislocation, which can have large negative financial impacts if not properly managed.
Value and information content of outsourcing
| Product | Argument for outsourcing | Outsourcing options | Information flow |
| Middle office | Acquire specialist resources and technology, lower management burden | Full outsourcing of a range of functions including fund accounting and trades processing | Low: end of period reporting meets management requirements |
| Agency lending | Not a core business, best conducted by dedicated suppliers, historical preference | Full outsourcing of trading, risk, data, collateral and operations | Low: end of period reporting meets most requirements while specialist vendors can supply additional information as needed |
| Trading | Lower cost, cost shifting, range of counterparties | Full outsourcing of trading and trading relationship management | High: trading can be an integral part of the portfolio management process |
| Repo | Remove regulatory reporting burden, reduce infrastructure and management costs | Continuum of outsourcing options including trading, post-trades processing and regulatory reporting | High: relationships can inform clients about market liquidity and provide assurance of balance sheet when needed |
A best practices model for agency repo
Société Générale has created a flexible model for agency repo, which is similar to what we see in agency lending and middle office outsourcing but with greater flexibility to meet the information and counterparty relationship management of individual clients. On the one hand of the scale is full outsourcing, where the client passes both repo trading and post-trades processing to us. We execute transactions based on our diverse market connectivity, report under SFTR, and provide the client back with transaction details. On the other hand is partial outsourcing, where the client keeps the trading activity and outsources all back office and regulatory reporting.
The Société Générale model is simple to access and implement. It leverages the well-known and tested Global Master Repo Agreement (GMRA) and Global Master Securities Lending Agreement (GMSLA) with an agency annex. This is a simplified version of the agency lending agreement adapted to a repo structure with Société Générale as the service provider. Trades are directly between the client and the market counterpart.
The option for a client to retain responsibility for repo trading is an important differentiator to the service. Aclient’s traders can access a large number of repo counterparts while benefitting from the indemnification of these trades. Clients can ask Société Générale to find prices, as in a normal agency lending structure, or keep pre-negotiation in-house using Société Générale to check limits and confirm indemnification of trades. The structure can run on a complete portfolio or trade by trade basis. Likewise, clients can outsource burdensome middle and back office flows to Société Générale or, on a bilateral basis, retain access to collateral information through third parties and custodians.
New ways of interacting have appeared in the repo markets that are increasing capacity and expanding the range of Straight-through Processing options for dealers and clients alike. Agency repo cuts across all of these alternatives to offer access to central counterparties (CCPs) and our own electronic distribution network. Agency repo becomes an add-on facilitation mechanism for clients to access the market, rather than a separate alternative that must be considered.
This range of flexible solutions works to the advantage of a diverse European client base, including insurance companies, corporations and asset managers. Some of these firms have limited market access, lack the bandwidth to automate or adopt an electronic repo trading platform and have other more pressing matters to attend to. Agency repo can eliminate the emerging difficulty of SFTR while delivering to our clients the right degree of control for their own business models. Like agency lending, middle office outsourcing and outsourced trading, there is room in the market for a valuable client service of agency repo.
About the Author
Christian Régis, Managing Director, is the Head of Société Générale Capital Market unit Liquidity Management Agency (LMA). LMA offers in particular Agency Lending and Intra-Day liquidity services to SG Securities Services and Capital Market institutional clients.
Christian started his career in 1993, joining SG group Inspection unit. He then moved to various functions within the Coverage division in charge of large multinational clients. Between 2002 and 2015, Christian took various positions in SG’s Listed Derivative and Prime Brokerage affiliates in Paris, Hong Kong and Tokyo. In 2016, he became Head of LMA.
Christian Régis is a graduate from Sciences Po Paris (1990), Paris Dauphine University (1991, master in Corporate Finance), Reading University (M.A. International Finance & Accounting) and has also studied Mandarin Chinese in France’s Institut National des Langues et Civilisation Orientales (2000).