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November 2021

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Unlocking the Benefits of Peer-to-Peer Repo Trading

FinanceDistrict

P2P repo can offer access to competitive financing costs across a range of collateral types and opportunities for improved yield.


In article two of our three-part series, Travis Keltner and Leslie Womack of our Funding and Collateral Solutions team examine how a global, buy-side focused custody bank can unlock the benefits of P2P repo trading.

Transforming securities financing markets: making P2P repo work
Buy-side participants in the repo market stand to gain multiple benefits frompeer-to-peer (P2P) trading, including incremental liquidity and returns.Unfortunately, persistent roadblocks, which we explored in the first article ofthis series, have prevented meaningful expansion beyond the current tradingecosystem intermediated by banks and dealers. Overcoming these roadblocks will require a scalable technical solution that connects trading partners, tradesettlement, custody and collateral management solutions. It may also requirerisk intermediation.

A global custody bank focused on the needs of buy-side institutions is a uniquelypositioned solution, as it may extend the network effects required to support asuccessful, end-to-end P2P marketplace. Key supporting pillars include:

Streamlined, standard contracts
A core ingredient for a successful P2P repo marketplace is a common contract with commercial terms that counterparties broadly agree are reasonable and balanced. Ideally, such a contract would be executed once by each peer participant, opening access to all other participants that have agreed to the same set of terms. Of course, each participant may then elect – or not elect – to trade with any other counterpart.

  • We have spent considerable time reviewingadministrative grace periods and mini-close-outs for foot-faults(instances other than credit distress) and varying tax regimes.

Access to a wide network of buy-side institutions
Global custody banks serve thousands of buy-side firms around the world, including a range of traditional and non-traditional asset managers, asset owners, companies and insurers. They provide custody services as well as trading, banking and research-related products. Clients are increasingly focused on efficient utilization of their cash and securities.

  • Buy-side interest in P2P trading models has escalated over time. Listening to the chorus of our clients’ needs, and exploring new, flexible fintech solutions with our clients’ input, we are convinced that large-scale peer trading opportunities are poised to take off.

Collateral management servicing of custody and non-custody trading
Many buy-side firms struggle to settle their securities financing transactions efficiently. While the largest buy-side firms may rely on dealer-focused tri-party models, access is not available to everyone. An end-to-end P2P solution offers an option for a buy-side focused, outsourced collateral management solution, including connectivity with settlement, custody and tri-party services. The right custodian is well-equipped to manage a variety of collateral security types and trade terms on an overnight and term basis, and they can support all needed messaging and communication between both buy-side parties. Its robust technical infrastructure and partnerships with upcoming and established technology vendors can accelerate efficient new cloud-based products that readily connect the complete value chain via application programming interfaces (APIs).

Credit intermediation to foster liquidity
Credit asymmetries among firms that otherwise would like to expand their P2P trading, and information and resource constraints for independent credit reviews, continue to limit the size of today’s P2P repo market. Large pension funds may be quite willing to face one another directly, but regular demand needs between such parties may be limited. Credit intermediation may be a valuable kick-starter to expand the peer trading network and regular trading volumes.

  • An analogous parallel is the securities lending market, where global custody banks frequently include indemnification of lenders against borrower default to facilitate lenders’ distribution of assets, especially to lesser-known or smaller counterparts. To support this indemnification, these banks have developed sophisticated internal credit risk management teams that model, measure, manage and price the risk of intermediating trades.To support similar credit intermediation for P2P repo transactions, banks must price their commitment appropriately and carry sufficient regulatory capital. Peer trading partners must evaluate the all-in price and returns that may be achieved. That said, we think there is sufficient spread in today’s marketplace to induce a credit intermediary to back peer transactions while still improving the overall rate of investment return and lowering borrowing costs for peer participants.

Availability of external credit assessment
Institutional credit data made available by a neutral, respected third party may support firms’ understanding of potential counterparties’ own risk profiles. It may also eliminate the need for credit intermediation or, possibly, support parties’ agreement to a “co-pay” –and/or cap a guarantee amount for certain transactions. Such agreements may further increase the overall rate of investment return and/or lower the borrowing cost for participants in the normal course.

A flexible electronic trading platform with decision-making tools
We consistently hear – and agree – that P2P trading will benefit from an electronic platform that facilitates peer buyer-seller interactions. However, historically, simple matchmaking has been insufficient to drive a scaled marketplace. A platform enabling P2P participants to seamlessly negotiate and execute transactions is a piece of the puzzle. A preferred trade platform should also include:

1. Integrated pre-trade decision-making tools, including analytics and total cost analysis

2. Simple, flexible tools to manage trading opportunities (e.g., indications of interest, request for quote, flexible negotiation of terms, ad-hoc collateral schedules)

3. Permission flows to allow one or more credit intermediaries to quickly approve transactions

4. Workflow and integration with collateral management services

The ideal partner for P2P
Global custody banks maintain broad relationships with various client types, all with a common need for asset servicing and liquidity solutions. They are well-positioned to handle, on an outsourced basis, trade settlement and associated collateral management for both existing clients and those with assets custodied elsewhere. Data-centricity and management is key. A global custodian has substation in-house technical skills, balance sheet and credit risk management expertise, and an ability to forge relationships with innovative fintech players.The road ahead may not be a straight highway, but we are convinced that a robust P2P trading marketplace is both desirable and achievable. Our clients are seeking to reduce their dependence on intermediaries and to develop new avenues of liquidity, and we believe that we are uniquely positioned to facilitate such a decentralized financing marketplace. As an institution, we are committed to creating better outcomes for the world’s investors and the people they serve. An expansion of our clients’ repo trading opportunities is one step closer to that goal.



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