A different investment climate

Annya Walker, Guest Writer

Regulatory focus has moved towards shifting the business model of the securities dealers away from a repurchase agreement (repo)-based intermediation model where the principal revenue source is net interest income, to one that is driven by more fee-based and trading activities.

The ultimate goal of the new regulatory thrust is to allow investors to assume more of the investment risk through collective investment schemes such as unit trusts and mutual funds.

Following the debt-restructuring exercise and finalisation of the International Monetary Fund deal, the Financial Services Commission (FSC) has suspended the licensing of new securities dealers with business models based on repo transactions and lifted the moratorium on the registration of new unit trusts.

As regulations change and securities firms change their core operations, it will mean embracing a product that is largely unpopular with Jamaican investors, who generally prefer instruments with a fixed return.

Jamaica stands in contrast to countries such as Trinidad and Tobago and the United States (US) where the unit trust/mutual fund-type investments are main stream.

However, regulatory changes suggest that local investors may eventually have to embrace the changing tides.

The repo business has long been the main staple of the securities industry. Securities dealers make a business out of borrowing short-term funding from investors - usually for one year or less - and investing these funds in longer-term FSC-approved securities.

By assuming this 'gapping risk', dealers earn the spread between their cost of funds and the return on their investments.

Because a repo is essentially a loan to the securities dealer, collateralised primarily by Government of Jamaica securities, the product represents an attractive value proposition to Jamaican investors.

From the point of view of the typical investor, it is a relatively low-risk investment with a guaranteed rate of return.

However, as Jamaica's letter of intent to the IMF outlined, the repo business is viewed by the fund and the regulators as a source of systemic risk, with the risks borne solely by the securities dealer.

It is in this context that the proposed amendments to the existing regulations are being pushed to help to reduce the risks and strengthen the sector to withstand shocks going forward.

The recent Jamaica Debt Exchange programme has resulted in a sharp reduction in the returns from fixed-income investments such as repurchase agreements.