In 2012, international investment manager 3i changed its business and financial strategy following a change of leadership. Among other things, this involved the group reducing gross debt and cash investments, and operating with a much smaller treasury team.
3i’s treasury team had previously invested in money market funds (MMFs) alongside a longer-term book of deposits and certificates of deposit (CDs). But, in 2012, it moved to investing primarily in MMFs, attracted by counterparty diversity, same-day liquidity, reasonable yields and low operational impact. Furthermore, the consolidated ‘X-ray’ reporting made available by money market portals in recent years made it easier to assess counterparty exposure across several fund investments.
But where are we now? Looking ahead, developing regulation of the banking and shadow banking sectors means that existing day-to-day investment products are, or are likely to become, less attractive either due to reduced availability or falling yields for corporates and non-bank financial institutions, such as 3i. These regulatory developments include:
As it started to prepare for the future and looked to diversify away from MMFs generally, 3i considered using deposits, commercial paper and CDs either through a self-managed portfolio or through outsourcing to a third party, via a segregated mandate.
As a segregated mandate would present many of the same issues as the proposed regulatory changes to MMFs, and because a self-managed portfolio would likely increase 3i’s individual bank exposures, we investigated repos as a low-risk investment with reasonable yields.
During the life of a repo, various operational activities relating to the asset take place
The legal form of a repo, or repurchase agreement, involves the purchase of an asset with a simultaneous agreement to sell back the asset at a pre-agreed price. Economically, the repo is similar to a secured deposit, with the difference between the purchase and sale price being analogous to an investment yield, and where the asset can be sold if the counterparty defaults.
During the life of a repo, various operational activities relating to the asset take place. These include related income being paid to the asset seller, and changes in the value of the assets requiring further assets or cash to be posted or received by the seller. A repo can take a bilateral form (where the asset buyer and seller undertake all the operational activity) or be tri-party (where an agent such as Euroclear or Clearstream performs the operational activity). 3i chose the tri-party form, as we wanted to outsource all operational activities to a third party while benefiting from the asset seller paying the tri-party custody fees.
3i set up relationships with both Euroclear and Clearstream, as some banks choose to deal with only one tri-party agent.
3i chose well-rated relationship banks to transact with because the primary repo counterparty risk was its key consideration, regardless of the quality of the assets involved in the transaction. When considering different asset types, the group’s main considerations were:
Robust processes have been established to notify the tri-party agent of a default under a global master repurchase agreement (GMRA), move the assets to an operational custody account, and then sell the assets, in the event of a counterparty defaulting.
Historically, repo legal contracts have been documented using a GMRA, although Clearstream offers the Clearstream Repurchase Conditions (CRC), which should be a simpler document with less negotiation required. The GMRA can be thought of in a similar way to an International Swaps and Derivatives Association master agreement, in that it covers how a default can occur and what happens as a result.
Typically, any new GMRAs negotiated now take less than a month to negotiate
The key risk for the asset purchaser is that, if the asset seller defaults, the administrator may try to challenge the contract, arguing that a true sale and purchase has not occurred. 3i chose to negotiate GMRAs with repo counterparties, since they are tried and tested, and have proven robust, under real default situations. Both GMRAs and CRCs have legal opinions available, supporting the view that a true sale and purchase has occurred. This provides a high degree of legal certainty to repo market participants.
The GMRA covers all bilateral repos, with certain terms being overridden by tri-party agency contracts where tri-party repo arrangements are used. 3i obtained GMRA proposals from various banks, taking legal advice to negotiate a broadly consistent standard: this process took about three months.
Typically, any new GMRAs negotiated now take less than a month to negotiate, with the removal of proposed cross-default and set-off clauses usually being the most contentious points. Certain law firms provide useful guides to the 2000 and 2011 GMRA forms, and Euroclear is now providing standard GMRA formats that are likely to be suitable for new tri-party repo participants.
The onboarding process with Euroclear and Clearstream typically takes six to eight weeks to complete and tends to happen in stages, with new documentation being provided at each point.
The asset seller, purchaser and tri-party agent must document which asset types are authorised for repo, including any restrictions and haircuts, with each agreement typically taking a week to implement.
A new repo participant needs to decide how to communicate with the tri-party agent and how to receive information on asset positions. This tends to be through SWIFT, the tri-party agent’s proprietary system or a third-party route. In order to minimise changes to existing systems and avoid taking on new systems, 3i chose to use Bloomberg to trade repos and to confirm them with both Euroclear and Clearstream. Euroclear and Clearstream email regular asset reports to 3i.
3i has chosen only to repo gilts for short-term, fixed-term sterling repos, although we are investigating evergreen repos and other asset types for the future. Yields are generally better than those offered by unsecured deposits and they are comparable to MMF net yields.
Matt Shelley is group treasurer at 3i
