Low Margins and Regulation Create Cash Management Challenges

With interest rates expected to remain relatively flat for at least another year, generating returns on cash pools has and will continue to be a challenge, said panelists at the 30th annual RMA conference on securities lending.

Panelists noted that short-term treasury rates are particularly low, and as a result, investors have looked either to debt with more than a one-year maturity date or moving away from U.S. Treasuries. For example, Brian McMahon, assistant treasurer at Pfizer, noted that his company is taking cash outside of the U.S. to Europe and countries such as Japan, where they then buy currency assets and convert the basis swap back into U.S. dollars.

“The flattening of the money market yield curve is a challenge,” said Thomas Motley, managing director at State Street. As another example of a solution to this challenge, his firm has looked outside of 2a-7 funds and found that “there’s good value in alternative repo collateral.”

However, as Robert Fort, managing director at BNY Mellon noted, companies will have to reevaluate the yield curve once the Federal Reserve winds down quantitative easing.

Panelists also said that other regulatory decisions such as the Supplementary Leverage Ratio (SLR) will have an effect on the repo market, as the SLR treats U.S. Treasuries the same as corporate debt for the risk-weighted assets portion of the equation. As a result, securities finance levels could decrease, since repo is generally a low-margin business, and thus might not be worth the capital costs.

Regulators are also examining ways to prevent fire sales of cash collateral reinvestment pools, and instead provide for the orderly liquidation of assets. Panelists said that while it might not be possible to totally remove the risk of a fire sale, the structure of the investments post-crisis means that such scenarios are less likely in general.

“We would never would invest in repo where we don’t understand the collateral, and we would price it on our own terms…that’s the first step in mitigating risk,” said Jerome Schneider, managing director and portfolio manager at PIMCO.

Frost also noted that investors are approaching cash collateral reinvestment more cautiously since the crisis with more emphasis on liquidity. “From a securities lending perspective, it needs to be liquid,” he said.

“Everyone is managing portfolios much more conservatively,” said Motley. “There is much more liquidity in securities lending cash portfolios, and that in and of itself alleviates some of the fears.“