Secured RMB Financing through HKMA’s Cross-Border Collateral Management Service
Repos are important for the development of the capital market in Hong Kong and will help to develop a more liquid secondary market.
While Renminbi (RMB) liquidity can be sourced from financial arrangements such as loans or swaps, the repo market provides a standardized and secured means to facilitate access to liquidity in the Hong Kong market. In particular, tri-party repo financing provides important administrative and operational support for the valuation, control and safekeeping of collateral. Tri-party collateral management solutions that support repurchase agreements, or repos, are common in other markets but relatively new in Hong Kong. A repo arrangement offers an alternative and secure means to access offshore RMB liquidity (sometimes also referred to as CNH). Increasing liquidity through secured financing could also be a critical and indispensable component of the successful internationalization of the RMB.
The introduction of the repo market
International financial institutions as well as multinational corporations are increasingly interested in accessing additional RMB liquidity to support their financing and investment activities. Since the secured financing market in Hong Kong is still developing, banks have accessed financing largely through the unsecured inter-bank or the swap market. In Hong Kong, as in other Asian economies, the repo market has remained relatively underdeveloped compared to the more well-established markets in the United States and Europe.
The Hong Kong Monetary Authority (HKMA) has been helping to increase access to secured financing by introducing new products such as cross-border collateral management. This tri-party repo service was launched in 2012 and created a platform to facilitate development of the repo market. Since repos are a fully secured trade arrangement and provide recourse to the associated collateral if the counterparty defaults, they offer the benefit of mitigating counterparty risk more effectively. Thus, they should attract more investors and improve liquidity in the RMB market.
Market practices for repos in Hong Kong
While tri-party collateral structures are common in U.S. and Europe, local banks in the Asia Pacific regions are less familiar with tri-party repo models and the operational framework supporting them. The HKMA has helped to establish and promote tri-party collateral management in the domestic market by partnering with J.P. Morgan and other collateral agents. This provides an operational and service model that ensures that collateral supporting repo transactions is properly maintained and that collateral is valued appropriately on a continuous basis.
Similar to other markets where repos are already commonly used, the two principals in the transaction will sign the underlying global master repurchase agreement and set the commercial terms of the transaction for an agreed period. A local bank that is long on RMB cash and wants to use its funds for financing to earn more interest, for example, can lend to global banks or broker-dealers. Financing can be secured by deciding on the amount of collateral required to cover the amount of the repo for the duration of the contract, the type of collateral and how possession of the collateral will be taken in the event of a default.
The collateral agent, the third party in the transaction, ensures that operational practices for the program are managed effectively and in line with the terms agreed upon between the trading counterparties.
The benefits of repos for the participants
The repo program in Hong Kong gives international market participants another option to source liquidity for trading activities in the RMB market, based on a familiar tri-party collateral management program. In fact, one of the key benefits of the program is that international banks or brokerdealers can leverage the securities collateral already lodged with their existing tri-party collateral agent to obtain RMB liquidity. It is expected that ongoing financial markets reform, especially in the context of the new capital regime introduced by Basel III, will provide further impetus to move from unsecured financing to the use of vehicles such as repos for secured financing of transactions.
Local banks lending RMB can also benefit from using the HKMA program, as they are able to access new trading counterparties and can also utilize a new vehicle that may enable them to receive a higher return.
Given these benefits, repos are important for the development of the capital market in Hong Kong and will help to develop a more liquid secondary market.
Growing the repo market
The HKMA has taken various steps to enhance the practicality of utilizing the repo program, such as extending the cutoff times for settlement to 11:30 p.m. Hong Kong time. The extended hours allow market participants located in Europe to participate in local Hong Kong trading, further expanding the pool of potential market participants in the repo market.
Further effort is still needed to help local players become familiar with the operational and systems requirements to support repo transactions. By using experienced global collateral agents, the HKMA is helping to spread repo best practices from other markets to Hong Kong.
Increased familiarity with commercial terms common in the repo market by local market participants is important for ensuring more successful trading relationships and market growth. For example, different levels of experience or risk appetite may cause a mismatch in terms of risk parameters, such as collateral haircuts. As such, using common best practices can help ensure that firms do not lose out on potential or existing trading opportunities.
A favorable alternative
Repos provide an alternative for global firms to access offshore RMB liquidity in Hong Kong, and for local banks to increase trading opportunities to lend their RMB deposits. The development of a local repo market is also an important aspect to support the internationalization of the offshore RMB market and further promote liquidity.