April 16, 2019
In a detailed report, the J.P. Morgan Global Research team unpacks sponsored repo, a growing market that takes a significant step in alleviating the regulatory costs of fixed-income financing in a post-crisis world.
“We believe sponsored repo cannibalizes less efficient forms of repo, ultimately freeing up capital and creating more capacity for banks to provide liquidity to the fixed-income markets,” wrote J.P. Morgan analysts Teresa Ho, Joshua Younger, Alex Roever and Ryan Lessing.
What is Sponsored Repo?
Sponsored repo is a transaction in which a dealer sponsors non-dealer counterparties onto Fixed Income Clearing Corporation’s (FICC) cleared repo platform – a system that matches and nets repo trades in U.S. government debt.
In a typical matched-book repo trade, a dealer would borrow $100 from a cash rich lender (e.g., a money market fund) and then on-lend the proceeds to a cash borrower (e.g., a hedge fund) in exchange for collateral. As part of this, the dealer would have to put up its own capital against $100 of repo exposure.
In sponsored repo, FICC intermediates both sides of the trade, thereby allowing dealers to net the transactions off against each other. This means the amount of capital banks have to hold is greatly decreased, allowing dealers to provide more balance sheet to clients or deploy capital towards other operations.
But this netting benefit comes at a cost, points out Younger. Dealers have to provide a guarantee to FICC with respect to all obligations of its sponsored members and post additional capital into FICC’s clearing fund. They may also have to post additional liquidity at FICC's Capped Contingent Liquidity Facility, which is a liquidity buffer that each netting member needs to maintain institutionally to support a potential liquidity crisis of the clearinghouse.
In sum: sponsored repo is largely a form of repo substitution, with dealers moving away from balance sheet intensive repo trades to something that's efficient, allowing the capital gained in the process to be redeployed towards other uses.
How Big is the Sponsored Repo Market and What’s the Growth Outlook?
MMFs reported holding $138 billion of sponsored repos as of December 2018. While this is only a fraction of the $5.1 trillion gross repo market, sponsored repo has come a long way since mid-2017 when MMFs began participating in the product.
In the near-term, FICC is expected to receive approval from the Securities Exchange Commission (SEC) to expand its cleared repo platform to other counterparties.
But the upside is limited, with FICC capping how much non-bank members can engage in sponsored repo to account for the somewhat riskier nature of these members relative to “well-capitalized” Bank Netting Members such as U.S. G-SIBs.
FICC repo exposures in money market funds ($B) has materially increased over the past 18 monthsSource: Crane Data, J.P. Morgan
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