How will tokenized MMFs scale to trillions AUM? pt.3

A few weeks ago I started the series “How will tokenized MMF scale to trillions AUM?” We looked at three traditional finance use cases that are likely to adopt tokenization for immediate benefits and that benefits scaled into very large numbers.

Having looked at US corporate cash management and derivatives collateral management in part 1 and part 2, we are wrapping up the series with intraday repo as our last stop.

Unlike the other two use cases, intraday repo is a new market enabled by tokenization. It is actually the one with the most traction out of the three. And potentially has the most immediate scaling path. 

In this week’s newsletter, we will look at the market from 3 lenses:

1. Problems of the traditional repo market and the Solution
2. Players in the intraday repo space
3. Potential for adoption growth given the existing market structure

Let’s dive in.

Problem

For financial firms and corporate treasurers alike, being able to meet daily cash needs is essential for the well-functioning of any companies. Any mismanagement of a firm’s day to day liquidity position can lead to liquidity shortfalls or substantial financial costs. 

In fact, liquidity management optimization and liquidity position adequacy are of regulatory importance and systemic criticality. Regulators are focused on how banks and other financial firms manage liquidity given that market disruptions could arise at any time from missteps or erroneous calculations. 

Intraday liquidity is the lifeblood of the financial system for the smooth functioning of financial markets. Every source and use of intraday liquidity sends a signal that helps us to understand how the overall financial system is functioning.

However, despite its criticality to the system, intraday liquidity needs lack adequate fine-tuned instruments to help firms manage their day to day liquidity needs.

Typically firms have to resort to overnight repurchase agreements (repo) in which the borrower sources liquidity in exchange for collateral, while simultaneously agreeing to buy back the securities the next day at a specified financing rate, to manage their day to day liquidity needs.  

However, this is like forcing a square peg into a round hole. A common issue with using repos to plug daily funding gaps is that repo is usually overnight, at a minimum, whereas the liquidity may only be required for a short period of time during the day. 

For example, borrowers may choose to enter into repo agreements on an overnight basis to cover payment or other cash outflows for just an hour or even minutes during the morning. Overnight repo also limits the flexibility of the lender to have cash returned in periods shorter than a 24-hour timeframe. 

This means that the fee and interest paid on the minimum overnight term will be significantly reduced and funding needs that measure in hours or minutes during the day can be met with greater flexibility. This means millions can be saved in funding costs. 

Solution

Enter the intraday repo.

In any repo transaction, there are two legs. The cash leg and the collateral leg. The most common type of collateral asset used in repo is US Treasuries, making up 70% of the total collateral composition.

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