Tue | Feb 20, 2018

FSC widens collateral pool for repos, breathes life into contracting trade

Published:Friday | February 9, 2018 | 12:00 AM
Steven Gooden, president of the Jamaica Securities Dealers Association and CEO of NCB Capital Markets Limited.
Everton McFarlance, executive director of the Financial Services Commission.
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The Financial Services Commission (FSC), in December, moved to widen the pool of allowable assets used as collateral for retail repos, a development that securities dealers say would be beneficial to companies seeking financing from the capital market.

The pool now includes corporate bonds issued by an investment-grade company.

Retail repos were once the bread-and-butter market for dealers, and popular among investors, including persons with small holdings. However, the FSC, citing a mismatch of assets, in which securities dealers were using long-term holdings to back short-term risk, began encouraging dealers to shift to fee-based products more than three years ago.

Investors choosing to remain in repos were asked to sign a new type of retail master repurchase agreement with their brokers.

With the policy shift, the market has seen gradual compression, with value of retail repo contracts compressing over time from a high of around $400 billion to $195.4 billion at December 2017.

"The changes are aimed at refining some inconsistencies in the pool of the allowable assets that were defined during the retail repo transition in 2015," the FSC told the Financial Gleaner.

"It is expected that the quality of the asset pool - as it relates to credit risks - would be improved, to the benefit of retail repo investors," the regulator said.

Still, Steven Gooden, president of the Jamaica Securities Dealers Association (JSDA), says one of the positive outcomes could be better rates on repo products.

JMMB Group, which is one of the largest holders of repo liabilities, added that the FSC decision could lead to more attractive funding levels for issuers of securities.

But asked whether it would lead to an increase in its own repo book, JMMB was non-committal, saying only that it will continue to guide retail clients using a "holistic portfolio approach". Last September, JMMB Group reported nearly $174 billion of repo liabilities, up $20 billion in the course of one year.

In a document outlining the forms of collateral which were now permitted, the FSC said that subsequent to the 2015 transition, the JSDA highlighted some inconsistencies in the pool of allowable assets published in the Securities Industry Advisory for the New Retail Repurchase Agreement Regulatory and Operational Framework.

"After several discussions, the FSC recognised that the inconsistencies have resulted in the exclusion of securities that are of a similar or higher quality than the ones currently defined in the pool, as well as some of the securities that are currently allowed in the pool are not clearly defined in the 2015 advisory," the regulator said.

Examples of the inconsistencies were the exclusion of corporate bonds issued by a company with an investment-grade rating, but the inclusion of corporate bonds issued by a non-investment-grade company that is guaranteed by a parent company with an investment grade.

Additionally, the pool excluded locally issued corporate bonds secured by cash, but included corporate bonds secured by less liquid assets, such as real estate with a first-mortgage lien.

The pool of assets were adjusted on January 2, with the issue of a new advisory establishing that the revised pool of allowable securities that can be used as underlying assets for retail repo transactions will include dematerialised and immobilised securities as specified by the FSC. They cover Government of Jamaica (GOJ) and other sovereign bonds, Bank of Jamaica securities, and foreign currency-denominated corporate and sovereign bonds.

Gooden told the Financial Gleaner that he does not expect the changes to lead to an expansion in repo books, but anticipates better diversification of assets for dealers.

"The new forms of collateral allow for securities dealers to provide a wider variety of credit exposures to client via the retail repo. This will translate to improved risk diversification for both dealer and client as well as the potential for better rates on the product," he said.

Gooden noted that 2017 was a record year for the capital markets with $105 billion worth of private placements subscribed by institutions and clients of high net worth, under the FSC's exempt distribution regime.

Easier access to funding

With the collateral changes, the JSDA president said companies would also be able to access funding more easily.

Gooden initially spoke of the widening collateral pool at the JSE Capital Markets Conference last month.

"The change, though it may appear simple, will significantly impact the market, making capacity of securities dealers. The expansion allows for a larger group of corporates to better access debt capital through dealer intermediation with the use of repo funding," the JSDA president said at the time.

"Additionally, securities issued by companies and agencies of the GOJ are now included. This will create greater appetite and better terms for funding GOJ-led infrastructure projects, as well as allow for the GOJ to improve its debt ratios through the removal of explicit guarantees, as dealers are now better able to execute their market-making mandate with these securities ...," he told the conference.

avia.collinder@gleanerjm.com