During the pandemic’s first wave, liquidity in the municipal bond market dried up almost completely. There were a few weeks during the second quarter of 2020 during which price discovery was almost impossible and funds were hit with unanticipated high outflows.
Both investment managers and regulators are keen to avoid potential liquidity problems, such as investors seeking to redeem shares of mutual funds and the manager unable to efficiently sell assets to fund those redemptions. That’s one reason investment managers often seek lines of credit, which can help ensure access to cash when unexpected events rattle markets and investors.
The rise in reverse repurchase agreements (reverse repos)
Across the industry, we are seeing increasing interest in reverse repurchase agreements, often known as reverse repos, which can serve as an alternative to a traditional line of credit.
Reverse repos are hitting the spotlight again‡, especially with the increased focus on interest rates, which are expected to rise multiples times this year.
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 access liquidity via a reverse repurchase agreement, by selling those securities to UMB with the agreement to repurchase them from UMB for up to 30 days later.
The specific terms of the agreement rate vary by asset type. A reverse repo program is structured to offer committed funds availability or, for a lower cost, access to funds upon bank review.
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 lessen.
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, s/he will have the ability to borrow up to the agreed upon amount for up to 30 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 a client’s individual needs, reverse repo can be an attractive alternative to for an investment manager. 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, potentially at a lower cost.
UMB’s reverse repo program is part of our effort to meet asset servicing clients’ needs comprehensively from supporting liquidity needs to fund administration to domestic and global custody and more.