Many local financial institutions have discontinued offering repurchase agreements, more popularly known as “repos”. However, repos should not be overlooked. Although simple in nature they are very useful short-term investments and can be a valuable addition to your portfolio.
A repurchase agreement can be thought of as a collateralized loan. The lender (investor) provides cash to the borrower in exchange for a security which acts as the collateral. At an agreed future date (usually a year or less), the borrower repurchases the same security with the initial cash received plus accrued interest.
Benefits of a repo
Repos generally provide a bit more yield than traditional money market instruments, such as Treasury bills, term deposits and certificates of deposit (CDs). The yield advantage depends on such factors as the repo’s maturity date and the credit quality of the repo’s collateral.
Repos provide the ability to invest cash for a short period of time, making them a critical component in the effort to manage liquidity. This is especially useful to corporate investors but also for retail investors. A repurchase agreement is also a useful place to accumulate or temporarily hold funds while waiting on market opportunities to arise.
High-quality debt securities are typically used in a repurchase agreement. The securities function as collateral in a repurchase agreement. It is because of this that repurchase agreements are generally low risk investments due to the underlying security functioning as collateral. However, investors should note that some institutions use higher risk securities as collateral which in turn makes the repo more risky- i.e., not all repos are created equal.
Another reason that a repo is deemed as low risk is because the repo market is usually regulated. In 2015 the Financial Services Commission, which regulates and supervises the securities industry in Jamaica, implemented several changes to reduce the potential risk of loss to persons who invest in repos, should a disruption occur in the securities industry or in the operations of an individual securities dealer. These changes included having the assets (securities) held in custody of an independent trustee, the Jamaica Central Securities Depository (JCSD) Trustee Services Limited. Previously the securities were held by the institution offering the repos.
What are the risks of repurchase agreements?
The largest risk in a repo is that the seller may fail to hold up their end of the agreement by not repurchasing the securities at the maturity date. In these situations, the buyer of the security may then need to liquidate the security in order to attempt to recover the cash that they invested. This is why it is important to know if the institution offering you the repo is able to repay you and also why the quality of the security used to back your repo is important.
Toni-Ann Neita-Elliott, CFP is the Vice President, Sales & Marketing at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm
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