Asset encumbrance - netting

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hubertd
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Joined: 21 Jul 2020, 23:48

Asset encumbrance - netting

Post by hubertd »

Hi,

My treasury is preparing to start transacting unsecured bond lending. Unsecured Bond lending via repo transactions will encumber the bond being lent. This is consistent with repo transactions already being transacted by Treasury.

Am I right that under IAS 32.48 catch-all netting can be applied, which enables balance sheet positions of the repo and reverse repo (cash legs) to net off with each other?
Does it also apply to the bond legs regarding encumbrance??
pub_acco
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Joined: 19 Mar 2020, 16:40

Re: Asset encumbrance - netting

Post by pub_acco »

To me, IAS 32.48 doesn't sound like a catch-all provision.... Anyway, what are you trying to offset? Are you going to lend and borrow bonds at the same time?
hubertd
Posts: 26
Joined: 21 Jul 2020, 23:48

Re: Asset encumbrance - netting

Post by hubertd »

Yes, exactly

Repo and Reverse Repo are transactions type which we already trade on a frequent basis. The haircut, which is standard for repo markets is higher (50%), giving a greater unsecured exposure (our Treasury generally transact gilts at 0% hair-cut)

We lend £200m Gilt with 50% haircut and receive £100m cash @ 5bps
We receive £100m Gilt with 0% haircut and lend £100m cash @ 25bps

Here, a Repo and Reverse Repo transactions are creating a £100m unsecured lending position. Treasury earn net 20bps carry and encumber £200m of Gilt receiving £100m of the same Gilt, leading to a net liquidity outflow of £100m:
* Treasury Pay 5bps for £100m Cash and place with BoE at 10bps = 5bps carry
* Treasury Receive 25bps for £100m Cash which is removed from BoE at 10bps = 15bms carry
* Treasury Lend £200m Gilt and Receive £100m of the same Gilt

Question is: would the enumbrance be grossed up (£200m and £100m) or can it be netted as £100m. This is important from the leverage and balance sheet metrics point of view.
pub_acco
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Re: Asset encumbrance - netting

Post by pub_acco »

So you are entering repo and reverse repo transactions, not outright lending of gilts. At the first repo, the 200M gilt remains on the balance sheet and instead a 100M borrowing is recognized:

Dr. Cash 100M
Cr. Borrowing from repo market 100M

Then, the 100M cash is invested in the second reverse repo:

Dr. Investment in repo market 100M
Cr. Cash 100M

The borrowing and investment might be presented on a net basis if the requirements of IAS 32.48 are met, but it seems like you have no way to express the unsecured 100M exposure on the face of the balance sheet.
hubertd
Posts: 26
Joined: 21 Jul 2020, 23:48

Re: Asset encumbrance - netting

Post by hubertd »

"it seems like you have no way to express the unsecured 100M exposure on the face of the balance sheet"

Unsecured Bond Lending is an off balance sheet transaction but at the same time the encumbrance reduces the liquidity metrics.

There are 2 mechanisms to manage the excess liquidity:
- Unsecured Bond Lending via the Securities Lending
- Repo/Reverse Repo mechanism

Our Treasury can already transact Repo and Reverse Repo (although on a secured basis receiving or paying cash as collateral) which enables the creation of the same synthetic position as Securities Lending.

Whether the Unsecured Bond Lending transaction is structured as a Repo and Reverse Repo or a Securities Lending in ultimately the counterparties preference and depends on the way they are accounted for.

What is important for us is the ability to net off cash and bond legs of the Repo/Reverse Repo. That will effect the liquidity and other balance sheet metrics (via encumbrance) even though the transaction is an off balance sheet one. If we can net encumbrance positions in line with IAS 32.48 that sorts out the only uncertainty we have here.
pub_acco
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Re: Asset encumbrance - netting

Post by pub_acco »

It's not clear for me what you are trying to offset.... Bond lending is an off balance sheet transaction so you have no liability recognized that can be set off against the bond. You cannot derecognize the bond itself either because the derecognition requirements under IFRS 9 aren't satisfied....
hubertd
Posts: 26
Joined: 21 Jul 2020, 23:48

Re: Asset encumbrance - netting

Post by hubertd »

Sorry. I was thinking I was clear enough.

We need to know if we can offset repo/reverse repo bond legs in unsecured lending transaction
I gave an example for earlier for encumbrance reporting puposes. 200m encumbered asset is quite different from 100m which would be a case if we could offset
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