Thought leadership: Simon Sourigon, Natixis

Thought leadership: Simon Sourigon, Natixis

What can the repo market do for nonbanks? And what is the main trend you are seeing in how clients are coming to you for financing solutions?

The objective is to combine Natixis’ desire for high-quality liquid assets with the opportunity for non-bank clients to receive better rates on cash than they would on deposit.
We are becoming increasingly focused on trading clients’ mid-term funding that can be returned to the bank in exchange for collateral. In most cases, this entails a packaged solution, whereupon Natixis gains an improvement in the collateral or receives cash in exchange for a fee. Our main clients for this service are institutions, asset managers, insurance companies and corporates.

What is the appeal to each party in the transaction?

Tightening liquidity coverage ratio (LCR) requirements under Basel III mean banks, including Natixis, have become more focused on improving the quality of the collateral they hold.

Current LCR requirements impose a 50% haircut on the main index equities we hold, and a 100% haircut on financial stocks, convertible bonds and non-main index equities. So, for a fee, we enable clients that are traditionally rich in high-quality securities – such as government bonds – to exchange these for lower quality assets.

Because these non-bank participants do not need to comply with LCR requirements, they can take lowerquality assets onto their balance sheets without difficulty – and still receive a pickup on their initial investment by providing the banks with some ratio.

What is more, historically low interest rates have meant that the pure depository return on cash invested in the short to medium-term, such as certificates or bank deposits, is close to zero. This is especially the case in the eurozone where, since June, the ECB has lowered the deposit rate to –0.1% and cut the main refinancing rate to 0.15%. By comparison, the rate of return on equity financing is very attractive.

Certainly, a fund that is prepared to take equities or other equity-linked assets in return for cash will enjoy much higher rates. A second factor is counterparty risk. In order to mitigate credit exposure, we use collateralised transactions rather than unsecured deposits.

Essentially, we offer secured funding for clients and better interest rates in exchange for their help in meeting our own funding or LCR requirements.

Can you explain how these transactions work?

Take the example of a large CAC40 company in France, one that is long cash in the mid-term. We can help increase their return on this cash through three ways that recreate the traditional depository function, but offer higher rates. The first option is the traditional bilateral repo.

The second involves repo through a tri-party agent, such as BNY Mellon, Clearstream, JPMorgan or Euroclear. And, the third entails a collateralised note. All routes provide improved counterparty risk management.
However, in the first two options, credit is still facing the bank itself whereas, in the third option, the risk posed by Natixis is removed entirely. Indeed, the independent fund structure of the note means that the risk associated with the quality of collateral is simply exchanged for the cash. Certainly, bringing a specialist tri-party provider into the loop also has its advantages, as it removes a large administrative headache from the client.

The provider conducts valuations, transfers required collateral and covers corporate actions – meaning firms do not have to bother with the time-consuming and expensive operational process of redesigning internal systems to receive new types of assets (for example, a fixed income manager receiving equities as collateral).

Indeed, all they need to concern themselves with is how to formulate the collateral schedule, and the provider will support this process.

From then on, the tri-party agent will conduct the valuation and ensure that appropriate margin has been received from the bank.

Furthermore, the fees for the tri-party agreement are paid by the bank on the other side of the repo trade. Tri-party repo providers, meanwhile, are keen to encourage this business. This is because the more new non-bank counterparties they have on-board, the greater business flow they can expect from other banks, which are keen to finance themselves from this asset-rich pool. The note structure is similar to this.

The issuer will issue a note to the investor and the cash will then go from the issuer to the bank, which is the counterparty of the issuer’s repo transaction – used to provide collateral to the note.

The transaction organises daily margining, again according to the stipulated collateral schedule, into the fund. The target of the fund unit is to maintain the value of the pool of collateral in line with the value of the loan. This is because it is a note rather than a contract-based transaction, such as a repo, and so there is no need to negotiate legal documentation between the parties. It also makes it much easier for investors coming from the unsecured deposit world.

What types of assets should the nonbank counterparty expect to receive?

The range of collateral we will take for these transactions is wider than simply cash and government bonds, but in every case the objective for Natixis is to improve the quality of the assets we hold. What differs between clients is the assets that they bring – whether cash, government bonds or a range of other high-quality collateral.

In many cases, clients in these transactions are more familiar with fixed income securities than equities. For example, on the asset management side, many are fixed income funds. But they often get too comfortable with the different risk profile associated with equity names.

How do you match the duration of the transaction to your regulatory responsibilities under LCR?

If we start with the basics, the purpose of the LCR is to analyse the financial strength of the banks in case of market disruption. Regulators will analyse the commitments of the banks by that term, and add in factors to the assets considered risky in terms of liquidity. Cash and govies, or government bonds, will be considered high quality, and financial assets such as bank stocks or bonds will be considered low quality.

The goal for the banks will be to finance or increase the quality of their low-grade assets above that term. This is why new kinds of clauses have become apparent – such as a 35-day notice call, or an early roll of transactions where you agree to roll one month before the original term. We also have to cater to clients’ requirements with regard to their own regulations around keeping investments cash equivalent.

How are you organised to service this new source of business?

The headquarters of the team is based in Paris. However, our team work closely with our colleagues based in London. This “knowledge and axe” sharing organisation also spreads to Frankfurt, New York, Tokyo and Hong Kong, where we are strengthening our presence through new sales forces and structuring teams. Indeed, the demand for these types of transactions has grown significantly.

In the first case, certain types of participants face tighter regulatory pressures for which this structure provides a relief. One example is Japanese insurers. Indeed, regulations tend to be stricter for the investors in these financing transactions. And though going through regulations and legal advice can be a time-consuming process, the structure established means additional transactions can be slotted in with minimum fuss. Looking at Asia, the question of counterparty risk is also important.

The effects of the eurozone crisis and continuing anxieties regarding European sovereigns and their banks have meant that several participants continue to avoid European banks.

The stipulation to avoid taking French assets from a French bank, say, means that Natixis has to route such business via our local entities in Asia or the US. Another defining characteristic of how our business is structured is its proximity to the stock loan desk.

This means that transactions can be priced very accurately and clients are able to get a clear picture of conditions in the financing market – for both the short and long term – that signal its capacity to absorb the trade they are seeking at the right prices. Because the repo desk is genuinely multi-asset, the close level of connectivity between fixed income and equity traders provides an opportunity to create further value.

For example, if the fixed income desk is not capable of providing the return that the client seek, we will be able to combine an equity component that does, and with minimum fuss.