Counterparty risk management remaining complicate, guaranteed deposits may be part of the solution

We all know how complex and inefficient counterparty risk management is, at corporate level (when it comes to short-term investments). How guaranteed deposits and triparty repos can be an excellent short-term investment alternative ensuring mitigation of risk combined with good return? Would it be a panacea for treasurers? There are solutions to automate processes and simplify documentation. Let’s see how to enhance asset management for treasurers.

There's nothing new about it, except the lightning speed with which the risk can materialize without us being able to act in time.

No one in the treasury business will dispute the difficulty of managing counterparty risk (i.e. investments made with third parties). Whatever the techniques used or the sophistication of the tools, this management remains highly uncertain. However, no one can deny that the risk is real. It's not long since a few banks in the USA and a huge one in Switzerland disappeared. Nothing new, you may think. True, but the factor that has completely revolutionized history is the speed with which a bank can disappear. In this turbulent and increasingly complicated environment, caution is the watchword for corporate treasurers. In our opinion, guaranteed deposits are a simplified, solid and alternative solution, which should form part of an overall strategy and complement any conservative investment strategy.

Guaranteed deposits

Guaranteed deposits and tri-party repos are indeed attractive short-term investment alternatives, offering a combination of safety, liquidity, and yield. However, while they mitigate certain risks, they are not a universal "panacea," as they come with limitations. No one can claim that their investment product is risk-free and the perfect “solution”. On the contrary, it is in the combination of instruments that we will find the reduction of (counterparty) risks. If, in addition, the instrument can be processed more “automatically” via a platform, who can complain?

Tri-Party Repos, what Are They?

They are a type of repurchase agreement where a third-party agent (usually a clearing bank or central counterparty) facilitates the transaction, ensuring secure custody and collateral management. The investor (cash lender) provides funds to a borrower (cash taker), who offers high-quality securities (e.g., government bonds) as collateral.

1.    Advantages:

o   Collateralization: Reduces credit risk by securing the transaction with high-quality, liquid assets.

o   Liquidity: Highly liquid market, with overnight or short-term maturities available.

o   Yield: Often provides higher returns than guaranteed deposits while maintaining a low-risk profile.

2.    Risk Mitigation:

o   Custody Protection: Third-party agents ensure proper segregation of collateral, reducing the risk of mismanagement.

o   Haircuts and Margining: Collateral is often valued conservatively (with a haircut) to cover potential market volatility.

3.    Drawbacks:

o   Counterparty Risk: While mitigated, some risk remains if the borrower defaults and the collateral value drops unexpectedly.

o   Operational Complexity: Requires robust systems and monitoring, which may not suit smaller investors.

They are alternative attractive products as the enable:

• Risk Mitigation: Both options minimize credit and market risks compared to unsecured lending or speculative investments.
• Liquidity: Both are readily available in liquid markets, making them suitable for short-term cash management.
• Regulatory Benefits: Compliant with most corporate and institutional risk frameworks for low-risk investments.

How to circumvent tri-party repos’ complexity?

Today, there are solutions to simplify access to this interesting product named “tri-party repo’s”. Treasury Spring, for example, offers "Guaranteed Deposits" through its platform of Fixed-Term Funds (FTFs). These are financial instruments that provide secured, transparent, and customizable options for managing excess liquidity while minimizing credit risk and maximizing returns. The key features of these deposits include:

(1) Investment-Grade Security: Treasury Spring's FTFs are backed by high-quality, investment-grade issuers such as sovereigns, corporates, or financial institutions, offering a level of safety and stability to investors.

(2) Diversification and Customization: The platform allows for tailored investment strategies, enabling corporate treasurers to diversify holdings across multiple tenors, credit ratings, and security types. Terms range from as short as one week to one year.

(3) Streamlined Digital Access: Treasury Spring's technology enables a single digital onboarding process for accessing a wide array of products, reducing the administrative burden while ensuring compliance with corporate investment guidelines.

Investors are fully exposed to the underlying counterparties they choose, ensuring that credit risk remains solely with those entities rather than with Treasury Spring itself, the intermediary entity. This model aims to simplify treasury management, optimize liquidity, and mitigate risks like negative yields or market volatility, making it a competitive alternative for institutional investors seeking efficient cash investment solutions.

ST investments: liquidity of investments versus risks related to these investments:

Can They Be a Panacea?

We must confess that no single investment solution can address all challenges. However, a guaranteed deposit, combined with diversified strategies of ST investments may help significantly mitigating risks. In this turbulent and increasingly complicated environment, caution is the watchword for corporate treasurers. In our opinion, guaranteed deposits are a simplified, solid and alternative solution, which should form part of an overall strategy and complement any conservative investment strategy. It goes without saying that, even when guaranteed, a non-refundable deposit will depend on the underlying collateral. In principle, if it is regularly upgraded to at least 100% (or more) of the deposit value, this should compensate for a total loss of principal (in the worst-case scenario). But prudence dictates that we do not claim to fully compensate for the loss, for sure. But isn't this already a revolution compared to the simple bank deposit? Only a little additional (but easy to understand) formalism explains it. If I'm offered collateral, I want to be sure that it has the claimed value, that it retains it despite fluctuating economic conditions, and that someone oversees monitoring the underlying. There is no better investment strategy than one that diversifies instruments and mitigates counterparty risk, without altering returns or the execution and processing of these instruments. The guaranteed deposits should be part of every single ST investment policy and strategy of corporate treasury departments.

Conclusion

Guaranteed deposits and tri-party repos are excellent tools for short-term investments that prioritize capital preservation and liquidity while offering modest returns. They are highly effective for mitigating risks and can serve as key components in a diversified treasury strategy. However, they should be viewed as part of a broader investment portfolio rather than a universal solution. Their limitations—especially in terms of yield and exposure to systemic risks—highlight the need for careful consideration of market conditions and complementary strategies.

François Masquelier, CEO of Simply Treasury – Luxembourg December 2024.

Disclaimer: This article was prepared by François Masquelier in his personal capacity. The opinion expressed in this article are the author’s own and do not necessarily reflect the view of the European Association of Corporate Treasurers (i.e., EACT).