Dealers, FSC remain at odds over retail repo market size
The Financial Services Commission (FSC) is still nudging securities dealers towards reducing their repo holdings despite the backstop in the form of a repo trust as a vehicle through which the companies will shed the risk associated with the bundled retail products.
Under this structure, individual investors will hold their repo investments through the trust starting September, where previously they were held on the issuing securities dealers' balance sheet.
Eventually, the retail market is expected to become the province of high rollers after the new investment thresholds - a minimum of $1m or US$10,000 - take effect at the end of the year.
President of the Jamaica Securities Dealers Association (JSDA), Julian Mair, says he has concerns about what he understands to be the FSC's plans to cut repo operations by one-third, or well above the original $80 billion that was first mooted.
Securities bundled into repo products include Bank of Jamaica and Government of Jamaica instruments and investment-grade securities which are either government- or corporate-issued.
At last estimate for the December quarter, the FSC valued the repo market at $416 billion. A one-third chop would take $140 billion out of the market.
Such a dramatic reduction, Mair insists, would weaken companies for which retail repos remain a big part of their business. It would, he said, damage the robust platform on which Jamaican-dollar lending is based; and create liquidity by taking away a "significant portion of demand".
The FSC shot back, however, saying that the balance sheet risk that the dealers already face includes liquidity risk, which the reform measures are meant to ameliorate.
"While the trust arrangement will significantly reduce the level of risks associated with the retail repo product, specifically legal and operational risks in the event of dealer's insolvency, the balance sheet risks still remain. These balance sheet risks include liquidity and interest rate risk," the regulator said via its communications department.
The FSC itself did not confirm its targeted nominal or proportionate shrinkage of the repo market, saying only it wanted to cull holdings "to a level that is considered systemically safe and prudentially manageable".
Regarding the retail repo trust, the regulator said the arrangement was pilot-tested in May and June and that migration of the existing contracts to the trust began in early July.
FSC's agenda to reduce the repo market to a more manageable size is itself a target of Jamaica's economic programme with the International Monetary Fund to reduce systemic risk.
The FSC said it is focused on market downsizing "against the background that the asset underlying retail repos will remain on the dealers' balance sheets and any movement in interest rates is likely to have an impact on the dealers' balance sheet, in particular, its capital".
Under the repo trust arrangement, the securities will be held in the name of the trustee on behalf of the client. For each retail repo, the beneficial interest in the underlying securities will be recognised in the register of the trustee and not the register of the issuers, which means more than one security may be assigned to a contract, the regulator said, while laying out the following example:
A client invests $1m in a retail repurchase agreement where the dealer assigns two underlying securities valued at $1,050,000, inclusive of the minimum margin requirement - ISIN 12345 - $500,000 and ISIN 67891 - $550,000; in the trustee's register, the client's beneficial interests in the underlying securities will be recorded as: ISIN 12345 - $500,000 and ISIN 67891- $550,000.
"The treatment of client's interest in the underlying securities is uncertain in the regime that currently exists," said the FSC. "In the new trust arrangement, if the dealer were to become insolvent, the securities would not form part of the dealer's asset to be distributed to their creditors."
As such, it added, the new system offered greater protection for investors in the event of a default or insolvency of the dealer.
The JCSD Trustees Services will act as repo trustee. Each retail repo investor will have an account with the trustee, which will maintain a record of the amounts invested by each repo client.
Answering a charge previously made by dealers that the FSC's persistent push to shrink the market further might be out of sync with current thinking by the IMF, the regulator affirmed that it was operating "based on the mandate" in the Memorandum of Economic and Financial Policies developed under Jamaica's Extended Fund Facility with its multilateral backer.
On Tuesday, the FSC issued a notice urging repo investors to sign a Master Retail Repurchase Agreement and then return it to dealers by August 31, which is the deadline by which investment firms must transfer legal ownership of the underlying retail repo securities to a trustee.