SPONSORED CONTENT | The diversifying face of the repo and securities lending market opens up new possibilities for Australian super funds to put their capital to work.
Reforms to international banking and financial system regulations since the global financial crisis (GFC) mean the market for ‘repos’ and securities lending, traditionally dominated by central and investment banks, is opening up to alternative lenders – including local superannuation funds.
With banks of all kinds now required to hold bigger capital buffers, large, sophisticated pension funds around the globe – including First State Super, an $80 billion default fund for NSW public servants – are stepping into the breach to create a more diverse market for repos and securities lending.
Repurchase agreements (repos) are similar to secured loans – with the important distinction that the title to the security passes to the cash provider for the duration of the agreement. Fixed-term repos can be short-term (often overnight) contracts, but can also be longer-term arrangements. Open repos, those with no fixed maturity date, allow the parties to renegotiate the interest rate daily.
Repos play an important role in assisting the smooth functioning of debt markets by promoting liquidity. They are the main instrument the Reserve Bank of Australia uses to undertake its domestic market operations.
As Australian Government bond issuance has grown over six-fold since 2009, so too has the market for repos. RBA data shows the gross value of the repo market at June 2017 was $215 billion, about three times bigger than it was in June 2009.
As the repo market has grown and come to include more varied participants, there has also been a shift towards tri-party, rather than bilateral settlement. Tri-party also makes it easier for smaller lenders to participate by allowing them to outsource the related settlement operations to a third party.
The Australian Securities Exchange (ASX), which offers a comprehensive range of collateral management services, recently hosted its inaugural Collateral Management Forum in Sydney on September 12, 2017, to explore the changing dynamics of the repo and securities lending market.
First State Super head of treasury and dealing, Michael Clavin, told the gathering the fund is exploring how to expand returns within its lending portfolio to gain more value from its cash collateral. Changes to the liquidity coverage ratio in recent years have already prompted First State to adopt a more active approach to its lending book.
“We have started working more closely with the agent lender on how term trades work and what we could commit to in regards to terming out some loans,” Clavin said.
He explained that First State Super has been comfortable doing term trades and has been entering into term trades within its securities lending program for the last four years, but the rewards associated with those trades are starting to come down as more participants enter the market.
“There are trades you can do with cash collateral that tie into what you’re doing on your lending book,” he said. “We’re looking at where it makes sense to trade directly with a counterparty and where it makes sense to use an agent.”
He believes this is part of a larger conversation around indemnification for asset owners and agent lenders.
“We’re looking at how we continue to remain an attractive lender, extracting as much value from our existing book as we can. We’re exploring pledge arrangements, looking at collateral upgrades and corporate action-related lending,” Clavin said.
A more international market
The RBA’s senior manager of domestic operations, David Olivan, told the ASX Collateral Management Forum of a significant increase in the number of overseas participants in the local repo and securities lending market.
Since the GFC, the RBA’s market share has reduced from 50 per cent to 25 per cent, while interbank participation has dropped from 30 per cent to 20 per cent. The share held by other participants has remained consistent at about 12 per cent to 15 per cent, but the mix of these other participants has become more varied, to include more corporate treasuries, pension funds and insurance companies.
Most notable has been the increasing share of offshore players, with the proportion of non-resident participants rising from 9 per cent to 40 per cent since the GFC.
Olivan noted how the collateral composition continues to evolve in line with changing market conditions and government bond supply. RBA data shows that, in 2009, about 50 per cent of all collateral traded under repo agreements was government bonds, compared with about 70 per cent today. During the GFC, private securities formed a larger part of the market.
Another big change has been the use of collateral management systems to achieve operational efficiencies.
“A third of all repos we transact now settle in ASX’s collateral management system,” Olivan said.
He explained that automated margin maintenance and post-trading analytics, as well as corporate action management, were among the benefits of using ASX’s collateral management system, freeing up the RBA’s resources.
Westpac executive director of group treasury, Mark Roche, noted that ASX’s tri-party system, and other market structure developments, have encouraged more unleveraged investors to enter the market. This is a positive development, he said.
“It’s key for us to have a healthy and big repo market to support liquidity in the government bond market.”
Roche said more competitive pricing in the repo market was making it more attractive to the bank in certain circumstances.
“Secured funding rates can trade above unsecured rates, that’s what’s thrown us into this market; it has encouraged unleveraged bond funds to provide cash,” he said.
Challenger is another ASX-listed financial services company that repos government securities. Chris Fleming, Challenger’s head of asset and liability management, said that, in the past, the life insurer mostly used swaps as the main hedging instrument for its long-term liabilities but it is increasingly using the repo market.
“Moves in bond markets drew us into government securities as a hedging instrument and the tri-party platform is an efficient way to access the market,” Fleming said. “We also see it as a flexible liquidity-management tool.”
He said ASX’s tri-party platform also delivers operational dividends.
“There’s no need to worry about stock substitutions; for a fixed fee, we are able to access an operationally efficient approach to executing hedging strategies.”
A maturing market
The local arm of US investment bank JP Morgan is now engaging more with local and global banks and directly entering larger, macro-term trades with banks through tri-party arrangements.
Jenny Cosentino, JP Morgan’s fixed income repo trader, said repos were increasingly important for the bank.
“Regulation has played a part in this, as has balance sheet optimisation,” Cosentino said.
She noted a need for more secured players in the market to provide the liquidity required to meet new regulations and cover the supply of bonds.
“We need to move from vanilla products to a more structured market and learn from offshore experience,” she said.
Citigroup is another US-based investment bank with a presence in the local market that is utilising tri-party arrangements in the local repos and securities lending markets.
“We’re looking at collateral upgrades, lending corporate bonds, and we are active in the cross-currency space,” Nathan Pederson, a director in Citi’s global markets team, said.
Stewart Cowan, executive director at JP Morgan for agency lending, highlighted the increased prevalence of structured transactions, with non-cash collateral trades now accounting for 65 per cent of his book. Whilst engaging in longer termed transactions has been a theme for many years, there is an increasing level of client engagement around managing cash and expanding collateral eligibility profiles to enable revenue to be maximised.
For local super funds and other institutional investors, this creates a need to educate risk committees. Pederson commented that, while the Australian market tends to move slowly, things are going in the right direction.
This report is sponsored by ASX Ltd.