Goldman Sachs and JPMorgan have found ways to keep trading in the $1.2tn US repo market while limiting regulatory burdens, potentially easing a cash crunch at the turn of the year.
Both banks are key players in the repo market, exchanging cash for high-quality collateral like US government debt — a vital financing tool that hit trouble amid a squeeze on funding a couple of months ago, which sent borrowing rates sharply higher.
Some analysts are braced for further turmoil in coming days, as lenders have tended to rein in repo activities around year-ends. That is when global regulators take snapshots of banks’ balance sheets to assess whether they have enough capital to keep trading through a big hit to the financial system.
However, in recent months Goldman has begun to mimic repo trading using derivatives known as total return swaps that carry lower capital requirements than regular repo trades, according to people familiar with the bank’s shift.
JPMorgan, meanwhile, has been encouraging its clients to use so-called “sponsored repo” deals, where a clearing house sits in between trades and allows dealers to net transactions off against each other, according to people with direct knowledge of the bank’s strategy.
Analysts said that the efforts of both banks, while designed to minimise their own capital requirements, should have the effect of alleviating cash pressures in the market. Both banks have “taken steps to be ahead of the game at year-end,” said Jeff Drobny, chief executive officer of Garda Capital Partners, a hedge fund manager. “It’s sensible.”
The New York Federal Reserve has been injecting money into the repo market for about three months, in an attempt to prevent interest rates moving outside the central bank’s target range. This month the Fed announced plans to inject almost half a trillion dollars into the market over the end of the year to keep markets ticking over.
Goldman and JPMorgan declined to comment. Each bank trades almost $200bn in the repo market each day, according to data from the Federal Reserve.
Both banks were on course to cross into a higher bracket, giving them a higher capital surcharge, when scores were last published at the end of the third quarter. The banks — which are both “globally systemically important banks” or GSIBs, in the eyes of the Basel Committee on Banking Supervision — have until the end of the year to reduce capital-intensive trading activity if they are to avoid such a penalty.
Goldman’s new strategy centres on reducing secured financing like repo for non-US clients, such as hedge funds domiciled abroad, said the people. Such operations attract heavy capital charges under Basel’s capital rules.
Total return swaps offer a way for hedge funds to replicate highly leveraged Treasury investments away from the repo market. The returns tied to a Treasury are created synthetically without owning the security, allowing funds to increase potential profits without borrowing more cash via repos.
JPMorgan’s shift achieves a similar goal. Typically, the bank would source cash through the repo market from investors such as money market funds, and then lend this out to other clients such as hedge funds.
Through sponsored repo, the bank’s capital costs are reduced because the bank faces the Fixed Income Clearing Corporation on both sides. Another benefit is that the FICC is classed as a domestic counterparty under the GSIB rules, so trades with non-US investors can receive more favourable capital treatment.
“We believe sponsored repo cannibalises less efficient forms of repo, ultimately freeing up capital and creating more capacity for banks to provide liquidity to the fixed-income markets,” JPMorgan analysts wrote in a research report earlier this year.