With repos, or securities repurchase agreements, many larger pension funds can lend directly, dispensing with the expense of money market fund manager fees altogether. The problem of dealing with the collateral exchanged in the repos process can be a hurdle, but this can be outsourced, says Bank of New York (BNY).
BNY offers global collateral management to institutional investors including pension funds, a service which is actually much broader than simply holding the securities involved in repos.
“We handle the trade from inception to maturity,” says Shavran Sood, head of business development and marketing for global collateral management at BNY in London.
Tri-party collateral management in the way that BNY offers it, is of particular interest to pension funds because of the risk control it provides in the repos process, he says. “In essence, pension funds, as institutional investors, are probably at the most risk-averse end of the spectrum.”
On the one hand, tri-party collateral management greatly reduces the risks involved, and on the other, risk in general is much better controlled.
When a pension fund decides to lend cash to a borrower, it can decide exactly what securities it is prepared to accept. The fund could have a multiplicity of very detailed rule sets on this, and with BNY, the service is automated, which prevents the fund from ending up with the wrong securities.
“For some counterparties they could agree 10 different rule sets and then pull the trigger on whichever one is appropriate at the time,” says Sood. This means the system is more flexible at no additional cost, he says. “It is a model which is extremely well suited to larger pension funds.”
The service means it is not necessary for the funds to build up a large infrastructure of their own to deal with this. “It’s one thing to hire traders that can generate substantial revenue, but nobody wants to invest in infrastructures that are purely cost centres,” he says.
It allows the pension funds’ traders to focus on what they do best, namely agreeing the trade and deciding which type of collateral – the structural side.
BNY then manages the collateral, marking it to market on a daily basis, which includes calling for more collateral when necessary, and then at the end of the period, doing the delivery in reverse.
Also, since interest rates are calculated daily, the bank increases the required capital on a daily basis. The service goes beyond simple collateral management, says Sood, and the whole thing is offered free of charge to the investor, because it is the cash receiver who pays for the service.
Although repos as a means of cash investment are only open to the larger pension funds - they need to have at least one trader saying daily how much will be lent and against which collateral - they can provide the fund with a higher level of net interest on cash than money market funds.
“It means the rate the borrower pays is received by the pension funds in its entirety; there are no crumbs off the table,” says Sood.