Killing the repo market has closed the US$ financing market for securities dealers


Wednesday, January 31, 2018

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In recognising Minister Audley Shaw as the “father of the junior market”, Steven Gooden, CEO of NCB Capital Markets noted, “Minister Shaw, why settle for being the father of the junior stock market? It is an accolade well deserved for [your] role in the development and protection of the junior market, but why not set an aspiration to be the father of Jamaica's modern-day capital markets? The industry stands ready to work with Government and all stakeholders to make this a reality.''

Essentially, given the mandate of the International Monetary Fund (IMF), the financial sector was compelled to remove the long-term funding needs of the Government and the short-term cash offered by investors for the suite of products offered by the industry. The regulators determined that it was simply too risky to allow the Jamaican financial sector to have this ongoing mismatch of long-term needs and short-term money. So investors have been weaned off repurchase agreements as mandated.

That said, another avenue of financing has been closed, perhaps inadvertently, in the process of removing access to repurchase agreements from small investors.

Gooden made these comments at the Jamaica Stock Exchange's 13th Annual Regional Investment Conference held last week at the Jamaica Pegasus in New Kingston.

“I want to throw down a challenge to the Government. This year, let's remove the obstacles to the efficient functioning of our capital markets. Let's allow the capital markets to play their part — an integral part — in us achieving the 5-in-4 economic growth aspiration. Let's make Jamaica, and by extension the regional capital markets, the poster child for capital market-led economic transformation among developing countries.”

To be clear, Gooden, who is also president of the Jamaica Securities Dealers Association, outlined a few of the frustrations that the industry faces. “The changes are many, but I am going to focus on three to get my point across.”

a) Allowable Assets

The pool of allowable assets in which a securities dealer can invest excludes foreign currency-denominated securities issued by local companies. The current framework allows investment in foreign governments and corporates that are rated investment grade, but does not allow the same foreign currency to flow to local companies engaged in productive enterprise. Since banks are able to offer foreign currency-denominated loans to these companies, there is no material impact on the foreign currency market by this omission. If companies have foreign currency funding needs, they will need to get bank funding with possibly less favourable terms and less flexibility. This measure only reduces competition and restricts access to various types of funding options required to support business growth.

b) 100% credit risk weighting for US$ GOJ securities

Among the slew of capital charges implemented on securities dealers, there is the 100 per cent credit risk weighting for US$ GOJ instruments. This weighting is equivalent to the risk weighting for private equity exposure under current risk-weighting standards. Private equity is the riskiest asset class that one could contemplate.

This level is inappropriate and inconsistent with international practice. Debt instruments of a sovereign are generally considered to be zero risk to 20 per cent risk weights, with adjustments for a market risk component at times.

Jamaica's experience has been such that debt restructures have taken place twice on Jamaican dollar-denominated debt, yet these securities are zero per cent weighted, while the global bonds have 100 per cent risk weight applied. Additionally, the market outlook, credit ratings and economic fundamentals for GOJ-issued global bonds has significantly improved over the last few years.

A reduction in risk weighting would release capital that could be redirected to providing further financing solutions to local corporates and infrastructural projects.

c) Exempt Distributions

Local entities seeking to issue US$ instruments exceeding US$35 million within a year, as well as securities dealers seeking to raise even a dollar, have to seek exemption from Minister of Finance, upon recommendation by the central bank, citing section 22 of the Bank of Jamaica Act.

Interestingly, Jamaica has no restrictions on foreign currency movements in and out of the country. Therefore, any corporate that has a need to deploy hard currency will be forced to convert anyway, as opposed to tapping into existing US$ liquidity…resulting in pressure on the foreign exchange market.

Secondly, this rule has negative implications for the pricing of US$ funding, as the capital markets would not be able to effectively compete with the traditionally less-flexible financing solutions.

Third, investors who really want hard assets will simply move their funds overseas if there is scarcity of quality local assets to invest in, creating a bigger problem — capital flight.

All is not gloomy in the financial industry, however. Gooden explained, “I want to comment on a recent regulatory change which is very encouraging and I want to really commend the FSC for pushing this through.

The change involves the expansion of the pool securities used as collateral for retail repos. The change, though it may appear simple, will significantly impact the market-making capacity of securities dealers.

“The expansion allows for a larger group of corporates to better access the debt capital through dealer intermediation with the use of repo funding.

“Additionally, securities issued by companies owned and agencies of GOJ are now included. This will create greater appetite and better terms for funding GOJ-led infrastructural projects, and will allow the GOJ to improve its debt ratios through the removal of explicit guarantees, as dealers are now better able to execute their market-making mandate with these securities, which would otherwise require a GOJ guarantee to be funded via client repos. I hope this move is an indication of greater levels of collaboration between the FSC and securities industry.”




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