Though only three months are left to go until the October 17 prime money fund reform deadline, the impact of the reform on repo rates is shaping up to be relatively minor, states Credit Suisse. In their August 3 research piece titled “Global Money Notes #7,” Zoltan Pozsar and Sarah Smith offer a one-by-one review of the balance sheet of every major foreign bank branch in New York that is a habitual issuer of unsecured paper to prime money funds.
Rapidly shortening tenor of foreign banks’ funding profile
The CS analysts relied on call reports from foreign bank branches for their report. They used the numbers on a branch-by-branch basis to peel the onion to uncover layers of “stress.”
Their research report has seven parts. In the first part, Pozsar and Smith explained the three phases of prime money fund reform and the dynamics that are currently driving the three-month U.S. dollar Libor higher by the day. They point out that July witnessed the maturity of $100 billion in formerly six-month unsecured funding provided by prime money funds to foreign banks in New York. They note that with just three months left for the October 17 prime money fund reform deadline, most of this funding was refinanced into three-month unsecured funding. The CS analysts point out that the rapidly shortening tenor of foreign banks’ funding profile from six months to three months and shrinking demand for three-month funding have been driving three-month Libor fixings higher since the middle of July.
The CS analysts point out that as funds get wired out of prime and into government funds, the latter will replace the proceeds with Treasury bills, agency discount notes, repos with primary dealers or, as a last resort, RRPs with the Fed. The analysts expect liquidity to be there for outflows and inflows to find assets to the last penny.
Options of bank funding desks to replace funding from prime money funds
In the second part, Pozsar and Smith highlighted the options of bank funding desks to replace funding from prime money funds. They explained why there is room for three-month Libor to catch up with the all-in cost of dollar funding raised via FX swaps.
They point out that judging from the recent issuance record of foreign banks, Canadian banks appear to be going down the path of term debt, and Japanese and French banks are showing a high tolerance for pain by borrowing for three months at 90 bps, versus Libor at 75 bps. They argue that while much higher than the current three-month Libor fixing, these levels are still cheaper than the all-in costs of using either JPY or EUR to raise dollar funding via FX swaps at 120 bps.
In parts three to six of their report, the CS analysts highlight the structural balance sheet features of the New York branches of four groups of foreign banks: those that do mostly arbitrage, those from Japan, those from the Eurozone and those from Canada. The analysts point out that the implications of prime fund reform are the least painful for these banks as their balance sheets are mostly about o/n arbitrage trades, which can be turned off and on with ease. They believe that for these banks, money fund reform will be as simple as shrinking their balance sheets.
In their seventh part, the CS analysts conclude by highlighting when it’s reasonable to expect foreign banks to tap the Fed’s dollar swap lines and why October will feel like a month-long quarter end. They note that as long as markets are continuous and trades get done, the Fed, the BoJ and the ECB encourage and expect banks to tap private markets, whatever the cost of funds. The analysts say the purpose of the swap operations appears to be to facilitate banks in sailing through the storm of money fund reform without a dent in their 30-day liquidity buffers.