Dim sum bonds tipped to boost nascent repo market

Dim sum bonds will be deployed as collateral in cross-border repurchase agreements by the end of this year, according to bankers.

Such a transaction will make clear the willingness of banks, prime brokers and other financial actors in the region to accept Asian securities to support their short-term funding needs.

Already, bankers say repo sellers are using Japanese and Korean treasuries, and Australian equities to borrow cash within the region.

While repos are rarely done in Asia except Australia and Japan, the use of local Asian securities such as dim sum bonds (offshore renminbi, or CNH, bonds), could incentivise banks to diversify their funding sources away from the unsecured interbank market.

“Banks are increasingly looking to use local Asian assets as collateral for repo transactions,” says O’Delle Burke, Asia-ex Japan head of collateral management at JP Morgan’s worldwide securities services.

In June, the Hong Kong Monetary Authority launched a tri-party cross-border collateral management platform in conjunction with JPMorgan and Euroclear. A maiden deal was done over a Hong Kong dollar tri-party repo between Bank of China (Hong Kong) and Barclays Bank this August.

Banking sources point to at least two other repo deals that could be done before the end of this year on the HKMA tri-party collateral management platform: one involving the borrowing of CNH-denominated funding; and another involving the pledging of dim sum bonds as collateral for funding in another currency. HKMA officials declined to comment on these discussions.

Basel III rules on liquidity ratios require banks to use highly liquid sovereign bonds as a liquidity back-stop, to cushion them against the risk of a run or a mismatch. Traditionally this has meant sovereign bonds from leading developed markets, particularly the US, but this is changing as banks and regulators change their view about what constitutes a risk asset.

Repurchase agreements involve buyers (the lenders) lending cash for a security with the promise of selling it back to the borrower. It’s like a secured loan, used to invest cash in order to finance long positions, obtain cheap funding or cover short positions. The security provided by the borrower is held as collateral, and may be itself reinvested to make a spread.

Growing acceptance of Asian securities by local lenders suggests borrowers, often banks, can make more effective use of their collateral pools and wean themselves from dependency on US Treasuries, the traditional tool to mitigate counterparty risk in over-the-counter deals. A US Treasury’s liquidity means a lender can always on-sell it should the counterparty fail.

That is not the case with dim sum bonds, which do not offer such liquidity.

Outstanding dim sum issuance was less than Rmb160 billion ($25.2 billion) as of end July, according to Bloomberg. While the first offshore RMB-denominated bond was issued by China Development Bank as far back as 2007, the market remains illiquid with secondary market activity sluggish.

However, borrowers of short-term funding (or repo sellers) are able to monetise the value of these securities instead of just earning coupons and holding them to maturity.

Industry players say that both fixed and floating rates will be used for pricing repos; for those of 30 days or less, a fixed rate will normally be used, while longer-term deals reference floating rate such as the Fed funds rate, Hibor or Libor, plus additional basis points as a premium.

JP Morgan’s Burke notes that while up to 70% of deals in the US repo market are done overnight, in Asia the majority of transactions are either seven or 30 days in duration, and overnight deals are rare.

The Hong Kong central bank launched its tri-party collateral management service as a way to promote development of the city’s cross-border repo market.

Banks have tended to rely on the unsecured interbank money market, and currency swaps, to borrow and lend funding in different currencies.

But Basel III requirements will encourage banks to secure sources of funding, and repo deals, given their collateral arrangements, start to look more attractive. If banks and prime brokers can operate in confidence in local securities, that will give Asia’s nascent repo market a boost.