Two articles on how corporates invest their cash caught our attention. Both were published on November 3, 2014. The first is from the Wall Street Journal “New Rules, New Corporate Puzzle: Where to Steer Cash?” by Vipal Monga and the second is from Treasury Peer’s Magnus Lind “Clearstream and Eurex Repo Discuss Repos and Clearing with Treasury Peer”.
This is not only about low and negative rates or the impact of money market fund reform (although those are important factors). We have heard that large corporates (and hedge funds too) have had trouble investing their cash. The blame is often placed on LCR, which looks at the cash as a wholesale asset that can be withdrawn on demand. This does not include cash required to be held in connection with clearing, custody and cash management activities. While non-financials don’t suffer under LCR as badly as financials, it still creates problems – banks don’t want the cash.
According to the WSJ article:
“…Nearly 1-in-3 executives at 164 companies surveyed in August by software maker SunGard Data Systems Inc. said their top worry was where to stash their cash…”
“…But international banking regulators recently updated their rules, designating “excess” cash deposits as high risk, because they were more likely to fly out a bank’s door during a crisis. As a result, regulators are demanding that banks hold more capital against those deposits, making then a costlier source of lending funds…”
So what to do? The Treasury Peer article mentioned some really interesting ideas. The article was an interview with Christian Rossler from Clearstream and Frank Gast from Eurex Repo. So what about repos as a place to park some cash? From the article:
“…The recent trend of corporates building huge cash balances may mean that we’d benefit from entering into repos to increase the yield and enhance the credit exposure. Collateral management is a new industry to most of us with a new vocabulary. The regulators are eagerly pushing corporations into repos to make banks increase the tenors and spread the depositor base. Corporations are mainly expected to be lenders, or collateral takers, which is in line with all new regulation imposed after 2009…”
The Treasury Peer article focused on European markets and the tri-party products. For corporates, tri-party is seen as a cleaner alternative to bilateral.
“…Secured cash investments are executed through repos which tend to be operationally complex on a bilateral basis. Therefore we experience a shift towards tri-party arrangements e.g. provided by Clearstream, where the provider manages the collateral on behalf of the corporate. In the interbank market the trend towards secured financing has led to a sharp increase of the outstanding volume of the Eurex Repo’s GC Pooling Market, the electronic and completely anonymous market for secured funding settled via Eurex Clearing as CCP (central counterparty). The cost efficiencies of central clearing are the main driver for banks to trade at GC Pooling…”
The article did not only focus on corporates lending cash, but also included the need to borrow securities (to post as collateral on OTC derivatives). Routing corporate trades via tri-party, using CCPs, would be very efficient. But the problem (at least in the US) has been mutualization. Non-banks have either been very reluctant to accept that risk or cannot by regulation. Eurex created a non-mutualized membership in their securities lending product, although it is limited to lenders of collateral only. But it looks like Eurex has done more than that.
“…Eurex Repo expanded the existing, successful interbank GC Pooling market to include a new segment for corporates, GC Pooling Select. In contrast to the anonymous interbank market, GC Pooling Select’s bilateral trading allows banks and corporates to continue their existing business relationships. Corporates can act as cash providers to banks quickly and easily, benefiting from the advantages of trading through a clearinghouse. Furthermore Deutsche Börse Group is planning to launch a new financing segment for asset managers, insurance companies and large corporates based on the GC Pooling Select framework. They will be able to invest as well as finance cash via repo transactions if they fulfill all requirements of a CCP member…”
It was that last sentence that got our attention. Exactly what is meant by “fulfill all requirements of a CCP member”? Is this a non-mutualized membership that can go in both directions (lending and borrowing of cash or securities) where the banks don’t intermediate the flows? If so, this could be a very interesting business model for repo CCPs in the US. It could maximize balance sheet netting, optimize capital utilization, make the regulators happy (given the increased use of central clearing), and maybe cure the common cold.
One word of caution: this does not mean that investors needn’t understand what the collateral is. In a default situation, the cash investors may find themselves owning some paper they didn’t expect and it could be fire sale time. Corporate investors should take as collateral what they know best and not just sign a collateral schedule and forget about it.
Clearstream is also working toward making it easier for corporates in the tri-party world.
“…A key argument for corporations is easy on boarding and small legal cost. Clearstream has designed a standardised tri-party-only principal agreement, the Clearstream Repurchase Conditions (CRCs)…. The standardised nature of this setup saves both time and legal costs. This innovation alone speed up the process for accessing tri-party repo counterparties by up to 12 month for corporates… To this end, Clearstream is continuously expanding its presence with its tri-party repo product on a large number of trading platforms such as Eurex Repo…”
While a standardized agreement may or may not be one size fits all, there is no question that compressing the time necessary to get agreements in place will be greeted with enthusiasm by the lawyers.
We wonder how FICC’s recent announcement to add a non-mutualized membership class for money market funds compares to what Eurex is doing? We have said that a repo CCP that is more inclusive should be the objective. We’ll have to do some more digging on this.
We have been on a roll with CCPs, especially repo CCPs. Take a look at our October 7, 2014 post “Repo CCPs for the buy-side – what will it take?”, the October 10, 2014 post “WSJ: FICC, CME and LCH.Clearnet all looking at repo CCPs“ and “The Bank of England explicitly includes CCPs for LOLR access. It is good policy.” (November, 10, 2014) among others.
Our apologies if the link to the Wall Street Journal article is behind the paywall.