Ongoing debt problems in Greece and other emerging markets are a constant reminder that risk has not gone away and this market uncertainty is motivating prudent corporate treasurers to hang on to their cash.
The overall liquidity pool in the corporate sector right now is very deep. And with some banks even charging corporate clients for depositing cash, investing cash securely while gaining some additional spread is becoming an increasingly challenging.
Oil is one sector that traditionally sees large cash concentration. At the end of Q1 2015, the Shell Group reported balance sheet cash of USD $20 billion with a cash flow from operating activities of USD $7.1 billion. It’s no wonder then, that Shell has a diverse cash investment portfolio that takes advantage of centralizing its cash in London with the support of regional centers in Singapore and Rio de Janeiro.
One important and well-used product in Shell’s cash investment suite has been tri-party repo, said Frances Hinden, vice president of treasury operations at Shell International Ltd. Shell signed its first tri-party repo agreement in 1997 but only began using the tool seriously around 10 years ago after a new front office recruit from the Bank of England asked why the company was not investing in repos. Back then, many processes were still manual and concerns about operational risk prevented Shell from investing much in repo.
A new master agreement
“We didn’t do much back then but we did set it all up,” said Hinden. “We had to agree Global Master Repurchase Agreements [GMRAs] with each counterparty individually and there are still scars on some of our legal team because one of the GMRAs in particular took five years to complete.”
The GMRA has been the industry standard international contract for more than two decades and has to be agreed bilaterally between each pair of counterparties. But horror stories, as experienced by Shell, have earned it the reputation for being sometimes difficult and expensive to negotiate.
Seeing that this was becoming a barrier to entry for some corporate treasurers led Clearstream to develop a standardized master agreement to help its clients enter the tri-party repo market. Unlike the bilateral GMRA, the CRC is multilateral so a repo participant only has to sign one document and is then able to trade with any other counterparties within the CRC community.
“My advice to other treasurers is not to do what we did and enter into a GMRA but use the standardized CRC with everyone, said Hinden. “The really painful part of this was negotiating the GMRA and if you can avoid that then it would make the whole set-up so much simpler.”
Having endured the pain means that Shell now has what Hinden calls a “bullet-proof GMRA” and tried and tested collateral eligibility criteria which are implemented with every new banking counterparty.
A simpler approach
The Shell treasury team collaborated closely with Clearstream and Bloomberg to overcome the operational risks intrinsic within largely manual processes. “We said what we would like to see and then Bloomberg set up new functionality and Clearstream set up the connectivity to them,” said Hinden.
“Typically, we agree one to two days before the investment and they confirm,” Hinden added. “The deal is then processed automatically straight through from Bloomberg to Clearstream. The only thing our team has to do separately is move the cash.”
Shell usually invests from seven up to 90 days in repo while its overnight liquidity is still mainly in money market funds (MMFs). The Shell treasury team chooses to accept only high-quality securities as collateral in accordance with its risk policy. This makes the repo very safe and yet still able to pick up a reasonable yield.
“It is common in the market to get higher yields on repos than on straight bank deposits and MMFs,” said Hinden. “But, of course, getting a higher yield with less risk is not logical from a theoretical point of view.”
Confounding the normal risk-return curve was down to regulatory arbitrage, explained Hinden. “The banks have high-quality liquid assets (HQLAs) and they need to make use of them while still maintaining a certain level of those securities in order to fulfill their capital requirements,” she said. “Repos make sense for banks as they actually don’t like taking short-term deposits because that penalizes them in terms of the amount of capital they have to hold.”
The upshot of this regulatory arbitrage effectively is that buy side institutions investing in repos gain increased yields and increased security. “What’s not to like?” said Hinden.
Steve Lethaby is Global Securities Finance Sales and Relationship Manager (UK, Ireland, Americas and South Africa) for Clearstream.
Read an expanded version of this article in an upcoming issue of Exchange magazine.