It's not about dunking the ball. The International Securities Association for Institutional Trade Communication on Sept. 7 published the workflow and content of messages to be used by fund managers and custodian banks in netting triparty repurchase agreements.
Fund managers should implement one of two versions of netting by Nov. 14, according to the Asset Managers Forum, a trade group of buy and sell-side firms organized under the Securities Industry and Financial Markets Association.
Netting in the world of settling equities and fixed-income financial instruments means condensing the obligations of counterparties to a single payment to a clearinghouse each day.
In the case of triparty repurchase agreements, it means reducing the number of times a fund manager through a custodian bank must send cash wire payments to or receiver payments form an agent bank for a broker-dealer.
"We have educated fund managers on the netting approaches and are building out capabilities in support of client requests and in alignment with market practice," said Erica Choinski, assistant vice president at Brown Brothers Harriman in Boston, who heads the ISITC's settlements working group which created the workflow and messages.
The workflow described by ISITC outlines the sequence of instructions which the fund manager must send its custodian bank and the custodian bank triparty agent banks such as Bank of New York Mellon and JPMorgan Chase to move cash from the fund manager's cash account at its custodian bank to the broker-dealers account at the agent bank of the broker-dealer. Likewise, the fund manager might end up receiving cash.
Right now, JPMorgan and BNY Mellon are the only two triparty repo agents in the $2 trillion U.S. market.
In triparty repurchase agreements, fund managers such as mutual funds and pension plans lend cash to brokers who post collateral in return. Triparty repos differ from bilateral repos in that a third party, such as JPMorgan and BNY Mellon, acts as an intermediary between lenders and borrowers and is responsible for administering the transaction. That includes taking in the collateral, allocating the collateral to each transaction, valuing it, substituting new collateral when needed and returning the cash to the lender, when due.
In a triparty reverse repo, as described by ISITC, collateral to back the repo deal moves from the broker to the triparty agent, such as JPMorgan or BNY Mellon. Cash moves from the custodian bank representing the fund manager to the triparty agent or from the triparty agent to the custodian bank. The fund manager needs to communicate to the custodian bank the netted-or final amount of cash-it must send the triparty agent or the amount it will receive each day.
Netting of triparty repurchase agreements was one of the recommendations made by a task force set up by the Federal Reserve Bank of New York in 2010 to come up with ways to reduce the intraday exposure BNY Mellon and JPMorgan faced to broker-dealers each day. The task force assigned the AMF to recommend the best way for fund managers to net their triparty repo agreements with their custodian banks. The AMF, in turn, partnered with ISITC to create the nitty-gritty details of how netting would be accomplished.
ISITC, a trade group of operations executives at buy and sell side firms, planned the workflow and messages to permit three variations of netting. The structure of the messages, which will confirm to the International Organization for Standardization (ISO) protocols, will be the same regardless of the type of netting used. The data within the messages will differ depending on the version of netting the fund manager selects. The messages will typically flow through the network operated by the Society for Worldwide Interbank Financial Telecommunication.
Here are the three types of netting for which ISITC has created a flow of work:
The single deal netting scenario: Each new repo deal is netted with each maturing repo deal or a deal which has been rolled over between a fund manager and each broker-dealer borrower.
The multiple deal single broker netting scenario: All of the fund manager's new and maturing repo deals are netting with each broker-dealer.
The multiple-deal multiple broker netting scenario: All of the fund managers new and maturing repo deals are netting with all of the broker-dealers it uses with each of the clearing banks.
One variation of netting did not make the cut: the fund manager netting all of its repo deals at a custodian bank with all of the broker-dealer counterparties at a clearing agent. It was considered too operationally challenging to achieve.
The AMF urged that fund managers use the multiple-deal single broker and multiple-deal multiple broker netting approaches. Of the three types of netting, the multiple deal single broker-netting scenario will end up being the most widely-used, according to two operations executives at fund management firms.
Fund managers must state to their custodian bank which form of netting they prefer, because the bank must be operationally geared to offer the choice. Regardless of their decision, fund managers, said Choinski, will need to code their order management systems to communicate the necessary information to their custodian banks.
Fund managers must send a "receive against payment" message, of the type designated by SWIFT as MT 541, to their custodian banks. This is used to send a cash payment to the broker-dealer's agent bank for settlement and get back a financial instrument. Or, to send an instrument and receive the cash payment.
The custodian bank would confirm the receipt of the MT 541 message and send a payment to the triparty repo bank representing the broker-dealer. In the case of a fund manager using the multiple-deal multiple broker model for netting, it is assumed that the triparty agent will know how to disperse funds between brokers.
Custodian banks, said Choinski, will also have some IT work to do: they must build out all of the logic to identify either the cash delivery or receipt instructions from the fund manager are for reporting purposes only or represent a payment to be made to a clearing agent or broker-dealer.
The ISITC paper titled "Tri-Party Repo Market Practice" can be downloaded from: http://www.isitc.org/market_practice/