Corporate cash starting to go to tri-party

A November 15th article in The Trade “More corporates pumping cash into repo market” caught our attention. The article said that Euroclear sees 10% of the tri-party activity going through the depository involve corporates, up from 0% before the financial crisis.

The cash pools held by large global corporates is estimated to be $1.5 trillion. All that money needs to go somewhere. Investing via tri-party has its advantages and drawbacks. Operationally, it is simple and requires little manual intervention. Cash lenders can specify on their schedule what kind of collateral they will take. It used to be that the schedules were fairly broad and all sorts of things could sneak in. Investment grade asset backed securities, for example, could have included clean car and credit card deals, but also senior tranches of securitized sub-prime debt. Schedules have gotten more granular.

But the allocation process for, say, corporate bonds could include surprises. Monitoring what is in a tri-party pool is difficult to do in real time. Liquidating corporates if the cash borrower defaults is tough to do and can easily turn into a fire sale situation.

Cash lenders have tradionally been less focused on their collateral and more focused on counterparty risk. As cash lenders look for more yield and go down the collateral credit curve, they need to be careful. Collateral is priced using external services and sometimes those levels can be off. One beauty of tri-party infrastructure is lots of small lots can be allocated as easily as larger ones. But the pricing for small lots is different from round lots, often by points. Using round lot prices for smaller pieces doesn’t reflect the real price that paper could be liquidated.

The use of tri-party by corporates, according to the article, comes at the expense of traditional bank deposits. Going from unsecured deposits to tri-party repo is a move toward greater safety. This is certainly a good thing.

We suspect that a lot of corporate money was already in bilateral sovereign repo and the move toward tri-party allows for  extracting higher yields by going down the collateral credit curve. Bilateral corporate tri-party, for example, is operationally intensive. Think of the difficulty of substitutions vs. the ease in tri-party. Tri-party is also a good vehicle to do term trades. Depending on the collateral, cash borrowers might find term deals advantageous for LCR purposes as well as a way to fund collateral transformation trades.

The move toward tri-party repo by corporates is, by and large, a positive development for everyone. It is not without risk….but what isn’t?

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