By Carol Penhale, managing director and practice lead for consulting and professional services at Broadridge
Sponsored Repurchase Agreements (SR) offer attractive benefits to both the buy-side and sell-side of the street. Of particular note for the sell-side, SR provides a vehicle to help keep clients ‘sticky’ by offering them privileges via their Fixed Income Clearing Corporation (FICC) membership. In a market where volumes and revenue are under pressure, strategies to maintain client retention are attractive.
Sponsored memberships for eligible clients of well-capitalized bank members (at least $5 billion in equity capital) at the Government Securities Division (GSD) have been available through FICC since 2005. As at the outset of 2019, the only two
Sponsoring Members were State Street and BNY (GSD Custody Model). Sponsored Member eligibility as of 2017 has expanded beyond Registered Investment Companies (RIC) and now includes all Qualified Institutional Buyer (QIB) clients of Sponsoring Member Banks to have eligible activity migrated to FICC and, in April of 2019, FICC introduced Category 2 SR which expanded the eligibility footprint.
Category 1 vs. Category 2 SR
While Category 1 (US Banks only) has been available for a while, Category 2 SR (non-US Banks, Broker/Dealers and Prime Brokerage) was announced by FICC in April, 2019 which has opened the doors to SR by a broad audience of market participants on the sell-side. For Category 2 SR, Sponsors can also let their clients trade with counterparties other than themselves. This allows sponsored members with the same execution flexibility as they have in the bi-lateral market today.
Securities eligible for SR programs
Eligible transactions will include two-directional overnight and term Delivery Versus Payment (DVP) repo in U.S. Treasury and Agency securities and outright purchases and sales of such securities. FICC acts as the Central Counterparty Clearing (CCP) agent for these transactions. Sponsored Members can be registered and/or non-registered investment companies. Eligible securities are:
- T-Bills, Bonds & Notes;
- US Tips;
- Non-Mortgage-Backed Agency Securities; and
Benefits and risks of SR - Building the business case for adoption
Weighing the pros/cons and fit of SR into your portfolio and building the business case for adoption are key. Understanding your capabilities and cost to handle these opportunities with your technology, work flows and current third-party relationships is also essential.
- Centrally clearing these repo transactions by non-Registered Investment Companies at FICC helps to alleviate borrowing constraints for these clients and potentially grows their on-loan balances and income as borrowers shift their demand to CCP channels.
Sponsor benefits include:
- Increased balance sheet optimization and capital efficiencies.
- Opportunities for enhanced customer relationships through the provision of agent services.
- Reduced liquidity risks.
FICC’s risk management of the arrangement occurs primarily at the Sponsoring Member level. The Sponsoring Member is responsible to FICC for posting all of the Clearing Fund associated with the activity of the Sponsoring Member Omnibus Account, which is calculated twice daily on a gross basis.
The Sponsored Member is principally liable to FICC for securities and funds only settlement obligations. Sponsoring Members must provide guarantee to FICC with regard to all obligation of it’s Sponsored Members.
Repo functionality best practices
Firms considering SRs are generally seasoned in the repo trading space and looking for new opportunities to build the book of business. Adding SRs and operational work flows frequently opens the doors to re-calibrate the tools to manage the repo book as a whole. As with any new asset class or trading methodology, back office and settlement capabilities top that list. Listed below are the core features/functions market participants want to add to their technology suite to manage back office and settlement needs:
- Front to back office repo processing;
- Quick and easy trade entry;
- All repo trade types, terms and rate types;
- Tri-party interfaces;
- Bulk event processing of all repo lifecycle events;
- Full audit trail;
- Automated settlement;
- Profit and loss reporting.
SRs are a rapidly emerging trend in the industry. Broadridge has seen strong interest with Category 1, and with the expanded footprint for Category 2, that interest has grown and begun to expand globally. Increased interest is anticipated as we enter 2020 based on client SR discussions we are in for evolving best practices and the activity from firms adopting our SR solutions.