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					12 sponsored report securities lending


tri--party                                                                                     sellers to tailor repo solutions to meet their needs without a
                                                                                               large investment in middle and back office infrastructure.
                                                                                                  An agent administers the repo transaction on behalf of
                                                                                               the buyer and seller and monitors compliance with its

solution                                                                                       terms. In addition to locating and matching buyers and sell-
                                                                                               ers, it establishes and monitors compliance with the legal
                                                                                               framework and undertakes pre-trade screening of securities
                                                                                               in accordance with client risk preferences, assuring that
The repurchase market offers capital security and                                              both partners operate within prescribed risk parameters.
                                                                                                  Acting as a middle office, the tri-party agent guides the
yield enhancement. Fred Francis argues in favour
                                                                                               repo buyer in establishing restrictions on collateral through
of the tri-party repo structure, which minimises the                                           a multi-tiered set of exposure limits and exclusions that
                                                                                               control eligible securities, margin ratios, exposures to
need for investment in back office functions                                                   currency, credit and market risks.

                                    he global portfolio is already a reality for many pen-     tri-party advantages
                              T     sion plans, yet the importance of short-term invest-
                                    ments is all too often overlooked. Effective use of
                              money market products involves both yield enhancement
                                                                                               For the buyer, using a tri-party agent provides yield
                                                                                               enhancement coupled with minimal credit and operational
                                                                                               risk and no settlement costs. Further cost savings are
                              and control of operational and credit risks.                     achieved by outsourcing risk monitoring and reporting. The
                                 Cash and near cash holdings have become increasingly          buyer also benefits from independent pricing and valuation
                              significant due to prolonged underperformance of equity          and low barriers to entry.
                              markets and the increased use of synthetic assets to gain           Meanwhile, the seller gains access to non-traditional buy-
                              access to foreign markets. For example, over the four-year       ers and new books of liquidity while benefiting from cost-
                              period through to 2003, 30-day Canadian T-Bills returned         effective financing and the optimal use of their securities
                              15.6 per cent. In contrast, US and Canadian broad market         inventory. Moreover, minimal human intervention means
                              indices generated only 4 per cent, while the MSCI EAFE lost
Francis: tri-party repo
structure is cost-effective
                              more than 29 per cent.                                           “minimal human
and comprehensive                As equity returns fell, money market yields declined and
                              forced the collapse of credit spreads at a time when credit      intervention means
                              quality was a concern. The dramatic collapse of a roll call of
                              trusted big names – Enron, WorldCom, Tyco, Global                operational risk
                              Crossing, Parmalat – has led to national regulators focusing
                              increasingly on credit and operational risk controls.            is reduced”
                                 This renewed emphasis on risk is also reflected in the
                              Bank for International Settlements (BIS) sponsored Basel II
                              Capital Accord, which underlines the need to assess and          operational risk is reduced, while settlement risk is nominal.
                              manage operational risk, as well as market and credit risk,      The agent also provides end of day collateral aggregation.
                              when it comes to establishing levels of capital adequacy.           Both buyer and seller benefit from flexibility of amount
                              The bottom line is that the industry must adhere to higher       and term. Using an agent means costs are lower because
                              standards for best practice in managing risk and ensuring        the agent provides the infrastructure, standardised legal
                              adequate security.                                               documentation and book entry settlement services.
                                                                                               Another major advantage of tri-party repo for buyer and
                              the repo effect                                                  seller is the ability to outsource the risk control function,
                              The repo market offers the opportunity for yield enhance-        which would normally require a costly middle office
                              ment while maintaining full security of capital. In a repo       infrastructure.
                              transaction, the buyer earns a predetermined return on
                              cash by purchasing securities, taking full title and posses-     optimisation problem
                              sion of them, and then reversing the purchase at the end of      The use of a tri-party agent thus addresses many of the
                              the repo term. The holding of security to mitigate credit risk   concerns inherent in bilateral repos. However, it should be
                              and the fixed return make the transaction comparable to a        remembered that the task of dynamically matching buyer
                              collateralised loan.                                             risk preferences and seller inventory throughout the term of
                                 In recent years, the repo market has expanded signifi-        a repo constitutes a complex optimisation problem that is
                              cantly. In the US, the average daily repo volume in 2003         solved only by significant investment in expertise and
                              totalled $4040bn, a 59.5 per cent increase over 2000. In         technology.
                              Europe, the total repo volume is about €4000bn, up 23 per           The repo market offers flexible investment opportunities,
                              cent from 2002 and 69 per cent from the level measured in        provides significant yield enhancement and full security of
                              2001. Today, repo auctions are the main instrument used by       capital. The tri-party repo structure provides a cost-
                              the European Central Bank to control reservable funds in         effective and comprehensive solution for clients seeking to
                              the banking sector.                                              minimise cost and operational risk without investing in back
                                 Outsourcing the administration of a repo book to a tri-       office infrastructure.
                              party agent is a cost-effective and comprehensive solution
                              for accessing the marketplace. The tri-party repo structure      Fred Francis is vice-president, securities finance and global
                              minimises cost and operational risk, allowing buyers and         products, at RBC Global Services

FTMandate                                                                                                                                   September 2004

				
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