Just under two weeks ago, Crane Data hosted its "basic training" conference, Money Fund University in Stamford, Conn. Among the highlights was a presentation from Teresa Ho of J.P. Morgan Securities, who conducted the "Instruments of the Money Markets Intro." We excerpt from her session below, and also quote from a new "Primer on sponsored repo" published by Ho and co-authors Alex Roever, Joshua Younger and Ryan Lessing. (Attendees and Crane Data subscribers may access our conference materials at the bottom of our "Content" page or our via our Money Fund University 2019 Download Center. As a reminder, make reservations soon if you plan on attending our upcoming Bond Fund Symposium, which is March 25-26 in Philadelphia.)
Ho outlined the basics, saying, "The money market is a sub-section of the fixed-income market and is comprised of instruments with high liquidity, short maturities of 13 months or less, and relatively low credit risk. Due to money market instruments' low risk and short maturity profile, returns are relatively lower than those of other fixed income securities. Because of the short-dated nature of the maturities, money markets instruments are rolled on a frequent basis."
She continued, "Generally, borrowers use [them] as a way to help them finance their short-term expenses. Investors use it as a way to help them manage their cash, also on a short-term basis. Others use it as a way to help them manage their interest-rate risk. Basically, as long as there's demand for liquidity, and as long there's a mismatch between cash inflows and cash outflows at an institution, there's going to be demand for the money markets."
J.P. Morgan forecasts that the total money market supply of securities this year is likely to grow by $485 billion, or 5%, excluding Fed offerings. A table included in Ho's presentation showed that significant supply increases are anticipated in these securities types: Treasury FRNs (16%), Domestic Financial CP (14%), Bonds (9%), Foreign Financial CP (8%), Treasury Bills (to increase the most by an estimated $153 billon) and Treasury Coupons (7% each), and lesser supply additions for Dealer Repo, Agency Discos and FRNs. No increases are projected in supply of ABCP or Yankee CDs. Shrinkage is likely for issuance of purchasable Agency Coupons (-23%) and non-Financial CP (-8%).
"The banks make up about 35 percent of the entire money market space," but she noted bank reliance on short-term wholesale funding has considerably lessened due to regulations crafted after the recent financial crisis. "At its peak in early 2008, total money market supply was around $11.5 trillion. If we take out Treasuries, [and] we're just talking about credit supply, that number is closer to $9.5 trillion. Fast forward to today. Those numbers are $10 and $6 trillion, respectively. So, over the past 10 years, we've seen a pretty dramatic reduction in credit supply of about $3.7 trillion."
"The most notable change, I think, has really been on the Treasury side. So, from 2009 to 2015, we've seen Treasury bill outstandings decline as Treasury decided to kind of change the way that they wanted to manage their debt portfolio.... But [since] around mid-2015, outstandings have pretty much reversed course and since then it's been up, and over the past probably three years it's been up by a trillion dollars. What is driving that increase? One [reason] is that Treasury wanted more liquidity in the bills market. The second reason is that they wanted more cash on hand to deal with sudden events," she commented.
Looking at repo markets, Ho observed that "Most of the exposures are now more towards foreign banks as opposed to U.S. banks." Citing a table of money funds' repo counterparty exposures across prime funds and govie funds and aggregating the notional repo exposures for the top five counterparties, she explained that "Over 40 percent of that are towards foreign banks. So why is that the case? Why are foreign banks taking off such a big part of the money markets? The reason as it relates particularly to repo is really around how leverage ratios are being calculated. There is a difference between how the regulators are imposing a leverage ratio for foreign banks and the leverage ratio being imposed on U.S. banks."
Finally, she added, "We are seeing some growth on the U.S. side in the repo markets. I think some of it is attributed to the development of sponsored repo. This is a new product that's been rolled out in mid-2017 to money funds as an alternative to access repo through the FICC platform. It's beneficial from the dealer side because it allows dealers to net their reverse repos and repos off balance sheet. So, it's less balance-sheet intensive ... it's a beneficial trade for dealers to engage in.... It's a way for them to reduce their balance sheet as well as their balance-sheet cost."
In related news, JPM's new primer dealing with sponsored repo, explains, "While the repo market has evolved in many ways since the Global Financial Crisis, repos are still a way for dealers to borrow or lend cash on a collateralized basis for a short time period. Based on the Fed's most recent primary dealer financing data, the gross size of the repo market is around $5.1tn (reverse repos: $2.3tn, repos: $2.8tn). However, these balances are a far cry from where they were pre-crisis in 2008 as post-crisis regulations have limited the amount of repos dealers can do with clients by significantly increasing the cost of bank balance sheets.... As a result, dealers are unable to offer as much financing/collateral, and consequently as much liquidity to the fixed income markets, relative to pre-crisis."
Ho, et. al., write, "Sponsored repo seeks to alleviate these pressures by better aligning the economics of repo with net exposure. By allowing netting members to sponsor non-dealer counterparties onto FICC's centrally clearing platform, dealers are able to provide balance sheet to end users without incurring as much capital. For end users, they get the benefit of obtaining another type of financing/collateral from dealers.... As its name suggests, sponsored repo is a type of transaction whereby the dealer sponsors a non-dealer counterparty in a cleared bilateral repo trade with FICC (Fixed Income Clearing Corporation)."
They add, "Currently, access to sponsored repo is limited given eligibility requirements. First, a sponsoring member must be a Bank Netting Member of FICC's Government Securities Division (GSD).... Second, the sponsoring member must demonstrate that it is "well-capitalized".... Third, the sponsoring member must have at least $5bn in equity capital. Fourth, to be sponsored, the end user must be a qualified institutional buyer client of a sponsored member (previously it was only available to registered investment companies). As a result, sponsored repo transactions have so far been mostly limited to large US banks that have been willing to sponsor their clients onto the FICC platform.... However, over the course of this year, more counterparties are expected to gain access to sponsored repo."
