The Financial Services Commission (FSC) indicates that its programme to tighten prudential requirements for security dealers in the retail repo market might possibly result in investments being deployed to areas such as corporate bonds, leading to more funding becoming available for that sector.

The 32 local firms whose core business is securities dealing had $909 billion in funds under management as at December 31, 2015, with almost half of their funds committed to retail repos.

However, in keeping with the requirements of the Memorandum of Economic and Financial Policies (MEFP) pursuant to the Extended Fund Facility extended by the International Monetary Fund (IMF) to the Government of Jamaica (GOJ), the FSC is required to introduce and gradually tighten the prudential standards for the sector.

The recently implemented prudential requirements include: (1) an operational risk-weighted assets component in the computation of the risk-weighted capital adequacy ratio; (2) liquidity management requirements and (3) stress-testing requirements.

The FSC told the Jamaica Observer that dealers are likely to review the impact that the changes will have on their operations and take those steps that support their business objectives and maximise returns, the implications of which may contribute to the growth in corporate bond markets.

“These available options, for the capital market, are in line with the global trend,” the FSC told the Business Observer.

Corporate bonds are debt securities issued by a company and sold to investors. They can be a major source of financing for local companies in the context of high cost or limited bank funding.

As at June 30, 2016, total corporate bonds in issue locally numbered 150 in total, with Jamaican dollar values of $45.5 billion and US dollar issues valued at US$645,327.

From a strong surge in 2014 — the year following the national debt exchange — when new issues rose to 106, issues have averaged about 60 within the last four years.

The FSC, in its periodical, the FSC Compass, asserts that dealers are already reducing their investment in retail repos. Total repo liabilities declined by 3.5 per cent for the quarter ending December 31.

The FSC said it is set on introducing other prudential requirements for the securities market (inclusive of the retail repo market), but will do so over the next three years.

Specific to retail repo will be the retail repo leverage ratio and restrictions on early encashments of retail repo contracts.

The retail repo leverage ratio will establish the minimum amount of capital that a dealer should maintain, based on the size of its retail repo liabilities, while restrictions on early encashment will ensure that contracts encashed prior to their contractual maturity date do not contribute to significant liquidity problems.

In a Securities industry advisory for prudential requirements dated March 2016, the FSC said that restrictions were also placed on the quality and type of assets which may underlie retail repo contracts.

In addition, the Securities (Prudential) Regulations 2014 outline other measures targeting the quality of the regulatory capital which dealers must hold.

In particular, the FSC said, the regulations only recognise ‘retained earnings reserve’ and not ‘retained earnings’ as a component of ‘tier 1 capital’.

“Generally speaking, ‘retained earnings’ form a significant component of a securities dealer’s ‘tier 1 capital’. Securities dealers will have to be allotted a sufficient time frame in order to transfer amounts from their retained earnings account to a ‘retained earnings reserve’ account. This will increase the permanent nature of their capital and reduce the ability to withdraw capital,” the FSC stated in the advisory.