By Carol Penhale, managing director and practice lead for consulting and professional services at Broadridge

The first Centrally Cleared Institutional Tri-Party (CCIT) trade was executed in July, 2018 by Citadel and Morgan Stanley. CCIT has opened the door to less complicated tri-party arrangements for the buy-side and while there is a learning curve for many buy-side firms at the collateral management and optimization table, it is a growing area of interest for them.

CCIT facilitates a peer-to-peer tri-party model, alleviating the traditional buy-side method of delivering collateral bilaterally across a custody network and agent bank. It has ushered in another notch in the shift of collateral management power from the sell-side to the buy-side and created opportunities for sell-side FICC members to assist the buy-side with access to CCIT.

CCIT enables dealers to trade general collateral repos, based on rate, term and underlying product throughout the day without requiring intra-day, trade-for-trade settlement on a Delivery-versus-Payment (DVP) basis. The key difference between GCF and CCIT is CCIT requires bi-lateral submission of trades from both parties to qualify for FICC netting. In GCF Repos the IDB submits to FICC on behalf of both parties.

What does this mean for the sell-side?

The tri-party repo market remains a critical source of funding for broker-dealers and an important cash management tool for institutional counterparties. CCIT offerings are another flag for the sell-side of the challenges they face to keep reinventing themselves and keep buy-side clients loyal and engaged for trade activity. Keeping the buy-side sticky has become a dominant theme for sell-side firms in the era of financial controls and increased technology options available to both sides of the street over the last decade.

Many sell-side collateral management shops are re-thinking how they remain competitive in this evolving marketplace. The business goals have shifted from growth to sustainability and attrition and with offerings to the buy-side to retain business such as more competitive structures and innovative offerings.

Benefits

There are several attractive features and benefits to buy-side and/or sell-side firms engaged in CCIT:

• GCF Repo service has removed the trading constraints that result from having to negotiate individual collateral arrangements between borrowing and lending dealers for each transaction resulting in increased liquidity for participants.
• CCIT will require 100% collateral unlike the 102% collateral required in the bilateral repo market.
• The transactions will have a full guarantee from FICC and it will collect margin from the borrowers to cover its exposure.
• Reduced liquidity, settlement, counterparty credit and operational risks.
• Additional borrowing source beyond tri-party and DVP repos will offer financing flexibility.
• Not having to assign collateral for each specific trade along with elimination of trade-by-trade DVP delivery requirements has reduced participants’ operational costs will be very attractive for increased efficiency, flexibility and lower costs for participants.
• FICC members may be eligible for “balance sheet netting” based on FASB Interpretation No. 41 (FIN 41).
• FICC’s guarantee of completion of settlement of the sponsored member’s eligible tri-party repo transactions with netting members. Settlement guarantee and risk management protections provide maximum safety for the general collateral repo marketplace. GCF Repos are guaranteed as soon as FICC receives the trade data, thus minimizing intra-day counterparty credit risk.
• Mitigate the risk of a large-scale exit by institutional firms from the US financial market in a stress scenario.
• A centralized liquidation of a failed counterparty by FICC would reduce the risk of “fire sales” that drive down asset prices and spread stress across the financial system.

Risks

While many measures have been put in place to remove deal and systemic risk from financial markets since the financial crisis and CCIT helps contribute to that risk reduction, there are still factors to be considered:

• Members may be allocated a loss after a succession of “waterfall-type” events in which other parties take first dibs at absorbing the loss stemming from a default. FICC have outlined the work flow associated with these events to allow firms assess their risk tolerance as part of CCIT deals.
• Members may not get their cash back immediately should a dealer they’ve lent to default, although the FICC will have their collateral.

Concluding notes

CCITs are one of the newest offerings that are changing the face of collateral management and collateral optimization. Many buy-side firms are evaluating their approach and strategies and sell-side firms are looking to offer buy-side firms advice and expertise in this area and the risk/reward ratio of CCIT impact and inclusion of these programs on their books of business.