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Corporates Move to Repos in Response to Negative Rates

  • By John Hintze
  • Published: 12/10/2015
ecblogo1The decision by the European Central Bank (ECB) to push its deposit rates even further into negative territory accentuates the rate anxiety corporate treasurers may face as they prepare budget assumptions for 2016. It may also serve to make short-term investment alternatives such as repurchase agreements (repos) more attractive.
    
Practically speaking, the difference between corporates’ cost to borrow funds and their returns from bank deposits and money market funds—the two main investment vehicles of corporates in Europe—remains at about 1.5 percent, with lower borrowing costs essentially compensating for lower investment returns, noted John Grout of the Association of Corporate Treasurers. That “cost of carry” spread has historically deviated only mildly for the euro and other European currencies whose deposit rates are now negative.
    
“The cost of holding cash when you have short-term borrowings, which most companies have, is unchanged,” whether rates are negative or well into the single digits, Grout said, noting the importance of briefing board members about the cost-of-carry notion.     
    
Nevertheless, some corporates with cash in Europe may not also have borrowings there, and regardless, there’s a tendency to want to want higher returns. Larger MNCs can use their relationship clout in their favor.
    
“A number of banks have approached me about lower rates, virtually every relationship bank, and I said, ‘No, you can’t do this, because we do business with you in other ways,’” said the treasurer of a large multinational media company. “So they backed off, and right now we’re not paying negative rates anywhere.”

Repos gain ground
    
In terms of short-term investments, repos have gained currency over the last year. Deutsche Börse’s Clearstream and Euroclear, which both manage tri-party repo services in Europe, have seen corporate participation increase significantly over the last year. Clearstream, says its volume of corporate repo activity increased to 23 percent from 15 percent over the last year, although some of that change stems from fewer bank participants, and its number of corporate clients has nearly doubled, with many more in the pipeline. The volume over Euroclear has nudged up, to just over 10 percent, as its overall trade volume has increased significantly, and it now has more than 60 large corporations as clients, including big names such as AstraZeneca and Microsoft, investing in repos.
    
Steve Lethaby, senior sales manager at Clearstream, said that historically the clearing and settlement house has had a number of petrochemical and energy companies participating in repos, because they tend to be cash rich and have the trading expertise. Efforts to facilitate access to repo counterparties over the last few years has spurred interest from smaller organizations with less than $1 billion to invest.
    
Rather than putting their cash into unsecured deposits, companies as well as local governments such as fire brigades and police authorities are realizing they can invest in repos with the same bank counterparty, and the investments are fully collateralized. In fact, the repos may pay a premium, since borrowing on a secured basis benefits the banks under new Basel III regulations. Corporates willing to engage in repos with lower quality collateral, instead relying on the bank counterparty’s credit quality, can actually turn a negative spread on the euro into a positive one.
    
“Driven by regulations, banks are bidding up to get access to the corporate community, especially those that don’t have corporates as core clients,” said Gösta Feige, director, product solutions, collateral management at Euroclear, which has also instituted measures to facilitate corporate access to the repo market.
    
Repos with higher quality collateral may still pay a negative rate, but evergreen structures, in which the repo perpetually rolls over until one or both parties agree to terminate the trade, are more likely to be in positive territory, Feige said.
    
“An investment bank with little access to cash from corporates will be willing to bid up a bit more than the traditional commercial or savings bank that has better access to that type of funding,” Feige said.
    
A longer version of this article will appear in an upcoming edition of AFP Exchange.

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