Two competing industry initiatives that aim to standardise the documentation of repackaged transactions are set to go head-to-head in the coming weeks, as they seek to tap into growing demand from a yield-hungry investor base for such trades.
Repack transactions combine debt securities and derivatives in a way that enable investors to customise their credit exposure – with bespoke payment dates, currencies or interest rates – in a single note issued through a special purpose vehicle.
The Spire platform, led by BNP Paribas, Citigroup, Credit Suisse and JP Morgan, will see notes issued out of a centralised SPV with standardised legal agreements that enable swaps to be transferred to another dealer in the event of defaulting swap counterparty.
Spire, which has been two years in the making, is set to go live in the coming weeks once law firm Linklaters finalises documentation.
Dealers believe the initiative will bring real multi-dealer secondary liquidity to the repack market. A number of investors are already lining up to use the platform with the first trades anticipated in early 2017.
“Our vision is to create an industry standard for SPVs that is similar to an ISDA for over-the-counter derivatives, where investors can do bilateral trades with a single bank or put banks in competition to find price transparency,” said a representative for the Spire platform. “Any client on board has the chance to get a quote from four banks and our intention is to grow that as widely as possible.”
Meanwhile, Deutsche Bank, Morgan Stanley, Nomura and Societe Generale have teamed up with law firm Simmons & Simmons for a rival project. It has similar long-term goals – but dealers will issue notes from their own Luxembourg-incorporated SPVs (see “Banks team up for standard repack terms”)
The primary focus of the documentation effort is to remove legal uncertainty over the role of a custodian for SPV-issued notes, after investors faced multi-year legal battles to get money out of such vehicles following the 2008 demise of Lehman Brothers.
Growth trajectory
Standardisation is expected to reduce costs and promote greater transparency in a repack market that dealers say is growing fast, fuelled in part by investor demand for higher yields against a backdrop of low and negative interest rates. No public figures are available on the market.
Investors – and particularly insurers – have money to invest but are unable to generate enough yield by sitting on government bonds. Many have turned to external issuers for structured notes to enhance that yield, but have given up liquidity along the way.
Repackaged transactions bridge that gap by combining liquid assets, such as government bonds or other high quality credits, with a range of OTC derivatives to customise exposures and payoffs. The standardised approach further builds on that liquidity by focusing on standard payoffs and liquid assets.
“If you want to unwind a repackaged trade, the asset is typically very liquid, but the swap part may be less liquid,” said the Spire representative. “With Spire, you can get a price from four banks and that creates real secondary market liquidity. We envisage it will be successful as it’s the direction that regulators are trying to move all parties.”
While the Spire platform accepts a wide variety of assets, it excludes CLOs, propriatary indices and other highly illiquid instruments that may be difficult for other banks to quote on.
Regulation
A typical repack trade can see overseas government bonds combined with cross currency swaps to offer domestic currency bond exposure in simple note format. Other examples might combine fixed and floating payments, enabling investors to gain exposure to long-dated government bonds with fixed coupons for the first two or three years, switching to floating format thereafter.
Also driving demand is tightening regulation of the US$544trn OTC derivatives market. While repack trades already present an opportunity for investors to gain exposure to OTC swaps without the need for ISDA documentation, from next March there could be added benefits as swaps participants will be required to post daily variation margin on OTC contracts that are not cleared through central counterparties.
By packaging swap exposures into note format, investors may be able to reduce the heavy collateral burden stemming from the new margin rules. Although the cost could be reduced, it would not fall to zero as the note must consist of cash or assets. Swaps struck between banks and the SPV would not be subject to margining requirements as securitisation vehicles are deemed to be non-financial counterparties and exempt from the rules.
As the two initiatives prepare for launch, dealers believe they could potentially join forces in the future. Some banks behind the standard documentation effort are understood to have had early talks about inclusion in the Spire group, but the project was limited to just four banks at launch.
“Once launched, we welcome any dealers onto the platform, within certain criteria and in line with procedures,” said the Spire representative.
HSBC will provide custody and trustee services to the new Spire platform, while independent fund administrator Sanne will provide administration services.