London 31/10/2016 - New regulatory requirements in commodities could kill off sale and repurchase agreements, known as repos, by making them much less financially attractive, John MacNamara of Deutsche Bank said.
"The death of repos is coming," MacNamara told delegates at the LME seminar during LME Week here on Monday October 31.
"Under Basel III, regulators want the level ratio [to measure activity] to be on returns on asset target instead of returns on equity. This, brutally speaking, means repos are on their way out," he added.
Repos have been a popular form of inventory financing in the past years. In essence, this is a commodity sale by a stock holder with a requirement or option to repurchase a similar commodity at a later date. The lender - often a bank - is protected by the ownership of the commodity during the transaction, while the stock holder can free up capital to trade or invest further.
Lenders typically find repos attractive because the ownership of the commodity reduces their capital requirements.
But the renewed focus on asset gains theoretically encourages banks to take on more risks in their commodity financing because it yields higher margins and thus bigger returns on assets. By contrast, cheap financing, including repos and letters of credit, become less attractive.
In addition, a few other developments are pushing lenders away from repo deals, including US regulation stating that banks should not be involved in proprietary trading and asset ownership.
The warehouse fraud scandal of Qingdao in China also highlighted the hazards of repos in commodity financing, underscoring the risks of misappropriation and multiple pledging.
Repos may also soon become less attractive from an accounting point of view because, under new proposed rules, financed inventory would need to be reported on a bank's balance sheet.
(Editing by Mark Shaw)