Central Bank. Authorized Repo Primary Dealers. Background * Objectives * BOT run REPO. Bilateral Repo. Borrower. Lender

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1 29 October 2007 Private REPURCHASE AGREEMENT (REPO) ธ รกรรมการขายโดยม ส ญญาว าจะซ อค นภาคเอกชน TOPICS Session Definition Background & Objectives BOT run REPO VS VS Bilateral Repo Characteristics of of Private Repo Private Repo in in offshore market Benefit of of Bond Repo 1 2 TOPICS Session Market Convention for for Private Repo Private Repo VS VS Buy and Sell back Definition* Market in which securities are exchanged for cash with an agreement to repurchase at the predetermined date in the future. Securities most commonly used as collateral are sovereign debt instruments. Transactions can be of any maturity, but are generally of a short maturity, ranging from overnight to one year. Cash Start Date Lender Borrower Securities / Collateral Securities / Collateral Maturity Date Lender Cash + Repo Interest Borrower 3 *Market Research and Development Team, Financial Markets and Reserve Management Department, Bank of Thailand 4

2 Background * Objectives * Began in 1998 when bond market was activated by the massive issuance of government bond for Financial Institutions Development Fund (FIDF) indemnification. The mechanism will allow one party to temporarily exchange cash for securities and the other to temporarily exchange securities for cash. Legal transfer of securities for the duration of the contract provides protection against credit risk. Mechanism to make the bond market a new investment alternative and then an efficient source of funding. 1. To facilitate bond market development. Adding liquidity to bond market Encouraging investment in bonds as investors can use bond as collateral to obtain cash if needed. Stimulating the financial institutions to be active market makers through short selling. Enhancing yield of the bondholders by lending it out 2. To broaden money market structure and to add on an instrument to the market toward collateralized term loan instead of clean loan. 3. To act as channel of central bank open market operations. 4. To be used as an alternative hedging instrument. *Market Research and Development Team, Financial Markets and Reserve Management Department, Bank of Thailand 5 *Market Research and Development Team, Financial Markets and Reserve Management Department, Bank of Thailand 6 BOT run REPO Bilateral Repo Central Bank Lender Central Bank Borrower Lending Borrowing Authorized Repo Primary Dealers 7 8

3 Private Repo Authorized Repo Primary Dealers Financial Institution Corporate and Retail Lending Borrowing List of REPO Primary Dealer 1. Bangkok Bank PLC. 2. Kasikornbank PLC. 3. Siam Commercial Bank PLC. 4. Standard Chartered Bank (Thai) PLC. 5. Government Saving Bank 6. United Overseas Bank (Thai) PLC. 7. Hongkong And Shanghai Banking Corp., Ltd. 8. Deutsche Bank Ag. 9. Krung Thai Bank PLC BOT-run repo market BOT-run repo market (Cont.) BOT-run market Bilateral repo market Private Repo market BOT-run market Bilateral repo market Private Repo market 1. Participants 2. Role of the BOT 3. Maturity Commercial Banks, Finance companies, FIDF and State En with MOF permission As a matchmaker 1, 7, 14 days 1,3 and 6 months Only Primary Dealers BOT actively adjust market liquidity or stability Mainly 1 days as it represents Policy Rate** Private Sector BOT expect PDs to bridge the liquidity from bilateral repo Mutually agreed between counterparties 5. Collateral Eligible securities 6. Agreement Government s securities, Central s bank securities, State-en with MOF or endorsed by the specific law under BOT s consent BOT s Regulation Same as stated in BOT repo market BOT s Regulation Mutually agreed between counterparties but generally use the same securities as stated in BOT repo market Standard Master agreement (GMRA) 4. Trading Session 1. Morning session : 9.30 am to pm 2. Afternoon session : pm to pm Only one session in the morning from 9.15 am to 9.45 am All day 11 *Market Research and Development Team, Financial Markets and Reserve Management Department, Bank of Thailand 12

4 What is Repo What is Repo Characteristic Characteristic Although legally a sequential pair of of trades, a repo is is essentially a short-term interest-bearing loan against collateral With the the underlying bond to to be be the the collateral, Repo is is more secured than common money market instruments Flexible tenor and good liquidity Despite of of using credit line to to control counter party s credit risk, daily mark to to market is is another mechanism to to immediately reflect counter parity s default risk Overnight repo rate normally runs slightly below the the Overnight Rate By By rolling repos, investors can keep surplus funds invested without losing liquidity or or incurring price risk What is Repo Repo Market in U.S. Pricing / Credit For Money Market Investors In In order order of of ascending yield yield 10 Days Repo < Inter-bank < In In order order of of descending credit credit Gov t Bonds + Specific Dealer s Credit > Specific Bank s Credit > 10 Days B/E Specific B/E Issuing by Company s Credit 15 U.S. Government Securities Dealers RP & RS Average Daily Outstanding as a % of U.S. Treasury Securities Outstanding 160% 140% 120% 100% 80% 60% 40% 20% 0% 3,307 19% RS RP 3,460 22% 3,457 Treasury Securities 27% 25% 29% 35% 3,356 3,281 34% 32% 33% 40% 43% 41% 44% 2,967 2,968 54% 3,205 49% 3,575 51% 66% 71% 56% 80% * $ Billion ,721 * Corporate securities are included from July Figures cover financing involving government, federal agency, and federal agency MBS securities. Source: Federal Reserve Bank of New York and U.S. Treasury

5 Repo Market in U.S. The Benefits of Bond Repo Position of Investment Banks For Central Bank Classification In Billion as Nov Bear Sterns As % of Total Assets As % of Total Equity Lehman Brothers In Billion as Nov As % of Total Assets As % of Total Equity Use repo // reverse repo to to manage the the aggregate reserves of of the the banking RP (Liability) % % % 695.9% system RS (Asset) % % % 612.3% Nowadays repo has become major Total Assets Total Equity % 3.46% 2,889% 100% % 3.81% 2,624% 100% instruments for for government to to execute the the monetary policy Source: Annual reports of Merrill Lynch and Lehman Brothers The Benefits of Bond Repo The Benefits of Bond Repo For Bond Dealers To To manage their liquidity To To finance their inventories on on a continuing basis To To speculate in in various ways Go Go short short treasury bonds bonds by by creating a bigger bigger RS RS position than than RP RP Simply Simply earn earn spreads between RP RP and and RS RS Create Create tenor tenor mismatch between RP RP and and RS RS For Commercial Banks Banks sometimes buy repo as as an an alternative to to unsecured interbank lending They also often enter into repo with dealers to to meet immediate funding needs 19 20

6 The Benefits of Bond Repo The Benefits of Bond Repo For Other Financial Institutions For Other Financial Institutions Money funds, large corporations, state and local governments, and foreign central banks are are big big repo money suppliers Insurance companies often enter into reverse repo transactions to to meet immediate funding needs Bond funds allocate their assets to to repo,, which is is deemed to to be be cash prepared for for redemption purposes With acceptable credit risk, overnight repos provide higher yield than 3-month Treasury bills Repo to the Whole Bond Market Key Successful Factors for Repo Market Repo to the Whole Bond Market A Golden Equation for Repo to the Whole Bond Market Standard repo agreement supported by by industry // government Efficient fund transfer, clearing system supported by by central bank Effective intraday overdraft line supported by by banks and central bank More liberal pricing // credit control mechanism A Successful Repo Market Less Liquidity / Funding Issue Broaden Market Participation High Secondary Market turnover of Government Bond Foundation Stone for the Whole Bond Market 23 24

7 DEFINITION BREAK Repo Rate = Interest on Deposit Repo Term = Duration of RP agreement (mostly days) Initial Margin = Hair cut Margin Threshold = Level of price tolerance or credit line Purchase Price = Deposit amount Repurchase Price = Original Deposit + Interest Required Securities Value = Number of collateral that need to be maintained FLOW Settlement Date Government Securities Deposit Deposit amount calculation ( Gross price x # units ) / ( 1 + Initial Margin ) ** Use TBMA RP reference yield of trade date with Settlement Date + 2 to calculate market value of collateral ** (

8 FLOW (cont.) Margin Maintenance** ( Market Value < Required Securities value ) Required Securities Value ** Monitor by TSD ** = ( Purchase price + Accrued repo interest ) x ( 1 + Initial margin ) +,- settled cash margin or Original deposit x RP rate(%) x days / 365 x ( 1 + Initial margin ) +,- settled cash margin Market Value = Gross Price calculated from average bidding yield of primary dealers shown in TBMA report on Cash/Securities deliver to TSD before am TSD Inform at 8.30 am inform Threshold = 10 Price Price movement FLOW (cont.) Margin Maintenance ( Market Value > Required Securities value ) Required Securities Value ** Monitor by TSD ** = ( Purchase Price + Accrued repo Interest ) X ( 1+ Initial Margin ) +,- settled cash margin or Original Loan x RP rate(%) x days / 365 X ( 1 + Initial Margin ) +,- settled cash margin Market Value = Gross Price calculated from average bidding yield of primary dealers shown in TBMA report on (add cash collateral and cumulative interest on cash margin, if any) Cash/Securities deliver to TSD before am Date 31 TSD Inform at 8.30 am inform 32

9 FLOW (cont.) FLOW (cont.) Interest on Cash Margin = Σ(Cash collateral x Rate announced by TSD x ( 1 / 365 ) ** Interest will be calculated daily but not compounded ** Maturity Date Scenario 1 There s no cash collateral during REPO period Interim payment of Cash Margin Interest Interest on cash margin have to be delivered at the last day of the month but not including the last date. End of month interest on cash margin Principal plus REPO interest Collateral TSD End of month interest on cash margin FLOW (cont.) FLOW (cont.) Maturity Date Scenario 2 There s cash collateral during REPO period 1. Collateral and Principal (including REPO interest) settlement Principal plus REPO interest Collateral 2. Interest on cash collateral Cash Margin plus Interest on Cash margin BASKET TRANSACTION Use more than 1 underlying assets as collateral. Margin (Maintenance) Net Margin within Basket If the net margin exceed threshold => call/deliver margin TSD Cash Margin plus Interest on Cash margin 35 36

10 EXAMPLE EXAMPLE (cont.) EXAMPLE : Bank A use Bond A 100,000 units and Bond B 100,000 units as collateral to borrow THB 195 million from Bank B with threshold of THB 1 million. Borrower Lender BASKET Bond A 100,000 units THB 195 million Bond B 100,000 units Market Value > Required Securities Value by THB 1.5 million (Threshold = 1 million) Component in the Basket Bond A Margin Exposure = THB 900,000 Bond B Margin Exposure = THB 600,000 Total = THB 1.5 million Margin exposure for each collateral is not over THRESHOLD. However, total exposure in the basket has exceeded THRESHOLD EXAMPLE (cont.) Comparison of Buy & Sell back VS Private Repo has to deliver THB 1.5 million for margin. *** If maturity date for RP transaction doesn t fall on the same date, cash margin plus interest from matured transaction will bring over to the last RP transaction.*** Item 1. Transaction 2. Margin Maintenance 3. TAX Buy & Sell back Easy to enter with no prerequisite agreement only buy and sell Transaction confirmation. None Both parties have to responsible for capital gains tax from buy & sell back transaction. Private Repo In general, Investors have to sign Master Agreement (i.e. GMRA) before entering any transactions. However, made it easier for investors with a more workable Thai version agreement. Both parties have obligation to monitor market movement and obligated to provide margin if price movement is greater than preset up threshold. Tax on capital gain is waived. Lender is still responsible for tax on interest earned from Private Repo transaction

11 Comparison of Buy & Sell back VS Private Repo Deposit Guarantee Insurance Period Guarantee size Item Buy & Sell back Private Repo First 6 month Setting up of the Deposit insurance company 4. Right on collateral in case of default. 5. Liquidity 6. Accounting entry Non default party doesn t have right on (so-called) collateral since they have the obligation to settle the transaction accordingly. Early Termination is non applicable Collateral has to put as company s asset. Buyer (non default party) has full right on fully or over collateral securities. Both parties (if agreed) have right to early terminate transaction. Under Private Repo, lender put it as Loan to xxx from Private Repo (ล กหน ตามส ญญาซ อค น). First Year Second Year Third Year Fourth Year Full amount 50 million 25 million 10 million Fifth Year 1 million THANK YOU Atachai Virojtecha Ext. 695 atachaiv@kgi.co.th 43