Managing liquidity is an important aspect of managing an investment fund. Many investment managers rely on traditional lines of credit to ensure readily available cash for shareholder redemptions or fund distributions. Those who expect heightened volatility—whether from geopolitical or economic factors—may be especially interested in exploring short-term credit facilities.
In recent years, investment managers are increasingly turning to a more efficient, less expensive option than traditional credit lines: reverse repurchase – often called reverse repo – agreements.
Note that in a standard repurchase agreement (repo), a party such as an asset manager acts as the cash lender, purchasing securities from a counterparty. In a reverse repo, the asset manager pledges securities and accesses cash.
How to use reverse repos
Various types of marketable, liquid securities are considered eligible for a reverse repo program. Less liquid, more esoteric securities may also be considered on a case-by-case basis. Asset managers with portfolios containing eligible securities custodied at UMB Bank, n.a. (UMB) can enter into a reverse repurchase agreement and sell those securities to UMB with the agreement to repurchase them within 60 days.
The specific terms of the agreement rate vary by asset type, which means that different securities can attract different rates based on their associated risk and liquidity profiles. A reverse repo program is structured to offer either committed funds availability, which guarantees cash flow for the asset manager, or, alternatively, access to funds upon bank review at a lower cost.
This flexibility allows institutions to manage their liquidity more efficiently, as it can be tailored to the needs of the fund manager and the financial institution.
Reverse repos are generally considered low risk, but asset managers should consider the strength of the bank offering the facility and, if funds are non-committed, the potential for funds to be unavailable during periods of high market stress.
Considerations before engaging reverse repos
The pricing and terms of reverse repo agreements can be influenced by the broader economic environment, including interest rate changes and regulatory conditions, which can affect the cost-effectiveness and practicality of engaging in reverse repos.
Consequently, fund managers must carefully consider these factors when structuring their reverse repo engagements to optimize financial outcomes and mitigate risks effectively.
A case study: Reverse repo benefits for fund managers
An asset management firm recently engaged UMB in a reverse repo agreement as part of launching a new fund focused on a type of fixed-income assets generally considered less liquid than, say, corporate high-yield bonds. As the client corresponded with regulators about the new fund, the regulator inquired about how the manager would ensure access to cash if the standard level of liquidity were to suddenly lower.
UMB collaborated with the client to structure a reverse repo agreement that considers the liquidity of the securities and, in the event the facility is drawn upon, can make funds available as fast as intraday (same day). Should the manager need to draw on the facility, they will have the ability to borrow up to the agreed upon amount for up to 60 days at a time, thereby reducing the potential for financial stress stemming from market liquidity pressure.
Are reverse repos right for your institution?
Depending on an investment manager’s individual needs, a reverse repo can be an attractive alternative to a line of credit. Specifically, if funds are only needed on an intermittent basis or the assets being used as collateral don’t work for other financing avenues, a reverse repo can be used to achieve a similar outcome for an investor—more quickly and potentially at a lower cost.
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