What are repos and why do we need horizontal repo markets?
A basic repo deal entails a short-term contractual arrangement between a lender and a borrower such that; the borrower obtains funds at an agreed interest and transfers the collateral security to the lender; after the agreed-upon period, the borrower repays the lender who then returns the collateral to the borrower.
We need horizontal repo markets because they promote market depth, dynamism, resiliency, and efficiency. They also mitigate systemic market risk, especially in a stressed market.
The Kenyan horizontal repo market has been dormant since 2014 mainly due to two closely related risks:
1. Contagion risk drove large financial institutions away from the horizontal repo market.
2. Collateral risk: Collateralization by pledging is inadequate for high systemic credit risk.
Collateralization by transfer doubly mitigates both risks thus enabling the revival of horizontal repos.
Even though the vertical repo market has been robust, the CBK prefers its regulatory role over market participation. For this reason, vertical repos are often hiked to limit borrowing and have shorter durations. Whereas horizontal repos offer longer durations, market-determined rates, and incentivize participation.
How does investing in the horizontal repo markets benefit you?
How does investing in the horizontal repo markets benefit you?
The repo market confers benefits to both the borrower and the lender:
The borrower:
• Obtains liquidity cheaply without offloading key investments, e.g. to meet working capital needs.
• Improves flexibility in the management of portfolios.
The lender:
• Diversifies into low-risk short-term interest earnings that earn more than fixed deposits.
• Fund managers can use repos to enhance yields.
How do we mitigate settlement risks?
How do we mitigate settlement risks?
Contagion and collateral risk: Recent reforms have allowed for collateralization by transfer; essentially a digital transfer from the borrower to the lender’s registry on the CBK’s CDS platform. Thus, the collateral isn’t vulnerable to being unavailable in the second leg of the transaction.
Market risk and credit/default risk: A haircut margin is offered to the lender to create an upside in the secondary market in the unlikely event of default. The same haircut mitigates market risk and is subject to factors such as the liquidity of the collateral security.
The transaction is secure: The transaction between the borrower and lender gets executed simultaneously within each of the 1st and 2nd legs with the settlement date and price captured clearly on the NSE repo board.
Where does Private Wealth Capital (PWCL) come in?
Market risk and credit/default risk: A haircut margin is offered to the lender to create an upside in the secondary market in the unlikely event of default. The same haircut mitigates market risk and is subject to factors such as the liquidity of the collateral security.
The transaction is secure: The transaction between the borrower and lender gets executed simultaneously within each of the 1st and 2nd legs with the settlement date and price captured clearly on the NSE repo board.
Where does Private Wealth Capital (PWCL) come in?
With this pretext, we are launching our repo brokerage services toward reinvigorating the horizontal repo market subject to the accompanying Horizontal Master Repurchase Agreement (MRA). Summarily, our role in the repo process and settlement entails the following:
• In the first leg:
o PWCL organizes a credible counterparty and carefully picks a liquid bond from the borrower’s portfolio. The buyer and seller agree on the entry and exit prices.
o The securities are exchanged on the NSE repo board and settled through the central bank.
• The second leg of the transaction (the inverse transaction of the first leg) takes place after the agreed duration.
• We ensure security:
o The original lender is secured through an ample haircut margin to enable a sale in the secondary market in the unlikely event of default. o A simultaneous transaction gets executed for the first and second legs with the settlement date and price captured clearly on the NSE repo board.
• NB:
o PWCL can offer attractive yields on government securities of between 50 bps to 150 bps above the prevailing market rates for periods between 2 weeks and 90 days.