Duelling repack platforms find common ground

Standard documentation initiative mulls shared SPV model as founders seek to join rival

One to one

Since 2016, the bond repackaging market has been divided by a common vision. Dealers want to tackle dangers revealed by the Lehman Brothers collapse, while also making the notes easier to buy and sell. But they have split into two groups – six banks on each side – over the details of how to get there.

For the past two years, each group has privately rubbished the efforts of the other. Now, they may be converging.

The Standard Repackaging Documentation initiative believes harmonised contracts will make the market safer and more liquid, but allows its participants to continue issuing notes from their own special-purpose vehicles (SPVs). Dealers behind Spire – the Single Platform Investment Repackaging Entity – agree with contract standardisation, but take it a step further, issuing their notes from a shared SPV.

The SRD banks now concede Spire’s model isn’t all bad.

SRD was conceived as a documentation standardisation project that could embrace as wide a market as possible and increase investor confidence. We have made definite progress towards standardisation, increasing liquidity and making repack vehicles more resilient. There is also an ongoing discussion to create a central SPV version of the initiative that could give further advantages while retaining the flexible documentation platform that we’ve already created,” says Jonathan Rogers, head of rates structuring for Europe, the Middle East and Africa (Emea) at Nomura.

The Japanese lender is a founding arranger of SRD alongside Deutsche Bank, Morgan Stanley and Societe Generale. BBVA and NatWest Markets have since signed up to the platform.

At the same time, dealers behind Spire may open the platform to regional players and asset-class specialists that are shut out under current rules, allowing both initiatives to fish in the same pool of potential members. As things stand, Spire’s terms insist any dealer should be able to step into the full range of transactions issued by all other dealers – a policy that limits the platform’s potential growth. Risk.net understands Nomura sought to join Spire at one point, but was excluded. Regionally focused dealers such as BBVA and NatWest Markets would also currently be barred.

Spire was founded by BNP Paribas, Citigroup, Credit Suisse and JP Morgan. Barclays and Goldman Sachs joined earlier this year.

Common goal

Bond repacks, which combine a bond and a derivative to customise the risk and reward of the instrument, have become a popular way for investors to generate yield. The rival initiatives seek to increase the liquidity of the notes through standardised legal documentation – in theory, boosting activity in the secondary market. Contract standardisation should also allow for the transfer of embedded swaps from a defaulted counterparty to a new dealer in order to keep the transaction alive.

Lehman Brothers’ bankruptcy in 2008 highlighted risks associated with issuing notes from SPVs. Swaps counterparties that were owed money by the bank had to wait years to retrieve what they were owed from the estate. Issuance of the instruments has halved since the crisis, according to industry estimates.

While initiatives that aim to standardise the largely bespoke instruments have been welcomed, participants have been split on the relative merits of the shared- versus separate-SPV models. 

But SRD’s possible move into multi-dealer-vehicle territory could be seen as an acknowledgement of the rival model’s appeal. It may also be an attempt to keep existing SRD banks on board.

According to two people familiar with the Spire platform, a founding SRD bank is one of three arrangers that were recently approved to join the multi-dealer SPV. Other members of the SRD consortium are also understood to have held talks with Spire.

Spokespeople for Deutsche Bank, Morgan Stanley, Nomura and Societe Generale declined to say whether they have applied to join the rival group.

Not all SRD members meet Spire’s entry requirements. Nomura is understood to have been turned down because it exited European equity derivatives in 2016.

As part of a strict set of rules aimed at bolstering liquidity, the multi-dealer SPV demands arrangers must be active across all derivatives asset classes and all regions. That ensures all banks are able to bid on an embedded swap from a defaulting counterparty.

Those requirements could soon be relaxed, however.

“I think we’re nearing the point of having reached that critical mass where we have enough universal banks on the platform to evolve to a phase where we could bring asset class or regional specialists on board, as baseline liquidity is already there,” says Nicolas Robin, head of equity derivatives specialist structuring at JP Morgan.

Over €1 billion ($1.17 billion) of notes have been issued from the SPV in the past 12 months, representing more than 20 transactions. Participating dealers estimate 10 arrangers could be live over the next six months – effectively exhausting the list of universal players.

Maintaining flexibility

Dealers on both platforms are mindful of the role regional specialists play in the repack market. For example, the addition of BBVA was seen by SRD as a breakthrough for that initiative, opening the door to Spanish insurers that have been active users of bond repacks in recent years.

Even if Spire does open the floodgates to all-comers, some still prefer the flexibility of the SRD approach. According to Natalia Cermeño, head of rates structuring at NatWest Markets, that flexibility was a crucial factor in the UK bank’s decision to join the initiative.

“We believe SRD was the right fit at this point in time, as it enables you to keep some of your flexibility while the approach is standardised and common. A single, multi-dealer SPV is something we discuss for the future, as it would allow for the best of both worlds. What’s important is that we give investors transparency, choice and liquidity,” says Cermeño.

Not all SRD banks are convinced by the merits of a multi-dealer SPV. According to Vadim Totskyy, head of the repackaging desk at Deutsche Bank, the separate-SPV model was crucial for building the platform in its early stages, and while the move to a shared vehicle is viewed by some as a natural progression, it may come with strict limitations.

“When starting the SRD initiative, we very deliberately felt that creating a vehicle shared by multiple arrangers is something that may be implemented later. It’s certainly possible to do but it can create some additional reputational and regulatory restrictions, and it can limit the scope and nature of transactions that can be executed through a single vehicle,” says Totskyy.

For example, banks would typically be reluctant to offer liquidity on a retail trade that has been arranged by another bank – one reason why Spire is limited to institutional investors. Also, the addition of new payout structures may require consent from all other arranger banks in a shared SPV model.

A single, multi-dealer SPV is something we discuss for the future, as it would allow for the best of both worlds
Natalia Cermeño, NatWest Markets

“With Palladium Global Investments [DB’s vehicle for note issuance under SRD] clients are not constrained by the payoff, collateral or whether the issue is public or private. If you only do vanilla business then there may be a benefit of a single vehicle as you only have to do KYC [know your customer] once,” says Totskyy.

Spire dealers agree the shared SPV model comes with limitations, but note the platform is not intended to replace banks’ existing SPVs.

“For standard terms and templates, we identified the types of transactions that we saw most readily in the market. In the equity space that is typically index-linked transactions, and in the rates space it has tended to be CMS-type payoffs that generate a pick-up in yield in the current rates environment. In credit, it includes single-name CDS in note format, so CLN-type products. No-one is talking about highly levered structures,” says Alistair Bloch, executive director in global rates markets at JP Morgan.

Some also raise concerns that a centralised vehicle used by multiple dealers could quickly rack up swaps notional to a level that would catapult it into costly clearing and margining requirements under the European Market Infrastructure Regulation. Non-financial counterparties, including SPVs, become subject to the requirements if outstanding interest rate swaps notional exceeds €3 billion notional.

Spire arrangers believe those fears may have been overplayed as Emir grants an exemption to hedging instruments when the threshold is calculated.

“Every swaps transaction in the SPV represents a hedge of the issuance, and with the advice of auditors, lawyers and consultants, we believe the set-up won’t allow for such an eventuality,” says Fatos Akbay, head of Emea rates structuring at BNP Paribas. “We’re keeping our eye on the size of the vehicle, however, which is exactly what we do with all of our own SPVs, and some of them can get quite large.”

Even in the event that the hedging exemption is lost, others suggest the vehicle could simply be cloned as swaps notional approaches the threshold.

Building liquidity

Dealers involved in Spire are hopeful it will hit €3 billion of issuance in the next 12 months. Liquidity in SRD is more difficult to assess given issuance comes out of separate bank SPVs and the private nature of many trades. There may also be SRD issuance by non-member arrangers as the open-source documentation is available on the consortium’s website for widespread use – something that is not thought to have happened yet.

Irish Stock Exchange data for the SRD vehicles show Deutsche Bank has one public issue outstanding from its Palladium Global Investments vehicle – a €13.7 million zero-coupon note due in 2059. SG’s Start Issuer vehicle has two notes listed with the exchange for a total notional of €93 million. Morgan Stanley’s Emerald Bay has two notes with a combined value of €135 million. ISE data also show the US bank used the vehicle to issue four pass-through notes that turned deposits of Novo Banco into tradable assets, paving the way for a debt restructuring that enabled the sale of the Portuguese bank.

Nomura has yet to issue notes from its Novello SPV – the vehicle for the Japanese dealer’s SRD activity, as clients continue to use the bank’s existing Novus vehicle.

“Repack markets as a whole are seeing resurgence, which is good news, so there’s room for co-existence. We have seen deals done on both, but a lot of clients are still perfectly happy to trade under old SPV programmes rather than move to a new one, even if it has got improvements,” says Nomura’s Rogers.

Repack markets as a whole are seeing resurgence, which is good news, so there’s room for co-existence
Jonathan Rogers, Nomura

NatWest’s Cermeño believes the existence of two separate initiatives is a positive sign for the market’s future growth.

“It shows the focus from arrangers to offer solutions in this space, so I think that’s a good thing. SPV notes enable investors to apply a tailor-made approach, but by making them more standard it may allow other banks to provide liquidity, so the SPV note could start trading more like an MTN. That would enhance usage as it would be easier and cheaper for investors to get involved,” says Cermeño.

So far, that secondary market has proved elusive. SRD banks are currently developing a framework to enhance interdealer liquidity with agreements to buy each other’s SPV notes and unpack in an orderly manner if investors want to sell. Even on the Spire platform, however, secondary liquidity has yet to emerge.

“Clients haven’t changed their behaviour just because they can, which has been surprising. We haven’t yet seen an actively traded secondary market or an increase in clients putting us in competition,” says BNP Paribas’ Akbay. “The main selling point has been the standardisation and ease of onboarding. Once you’ve done the legal work, whoever you trade with, the term sheet looks exactly the same and that helps investors.”

Spire documentation was developed in conjunction with Linklaters. HSBC provides custody and trustee services, while Sanne administers the platform.

SRD documentation was developed with Simmons & Simmons. It is supported by a range of agents and service providers, including BNY Mellon, HSBC and Law Debenture. 

Editing by Duncan Wood

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