Recent market activity has been exceptionally volatile. Forecasts for the economy change month to month as fears around inflation and the ever-changing path for interest rates continue to mount. This has been especially prevalent in the UK where inflation proves to be stubborn and interest rates threaten to move higher still. This is combined with uncertainty in the banking sector following the collapse of a number of banks across the US and Switzerland.
Although fears of potential contagion effects across the global banking sector certainly did not come to pass as severely as markets initially worried about, there was a period of weakness for banks which was characterised by falling share prices and increasing credit default swap (CDS) prices. This exposed investors to the potential of bail-in risk whereby banks that experience a material loss in assets can use investors’ funds to cover some of these losses in an event known as a bail-in. This highlights the importance of not only counterparty due diligence but also diversifying into secured investments that would be exempt from bail-in.
Unsecured investments are, as the name suggests, not secured on anything. Should the counterparty go into financial difficulty the investor generally has little recourse to reclaim their investment. In the case of bank deposits, and with some exceptions including local authorities, the Financial Services Compensation Scheme (FSCS) secures your investments up to £85,000 which is useful to the average retail depositor. But for institutional clients whose investments can range into the millions, this does not provide much security.
A secured investment is one that is backed by some kind of asset so if the counterparty should go into default, even if you do not get your original cash investment back you would have access to an asset of equivalent value. These investments can be backed by a variety of assets such as physical assets like properties or debt obligations like mortgages or bonds. Where clients have large balances of unsecured investments it might be prudent to consider switching at least a portion of these balances into secured options to better protect investments against default or bail-in risk.
Placing secured deposits provides a massive additional amount of security as, unlike with unsecured deposits, you are exempt from bail-in which would stop your funds from being used to cover losses during a default. Additionally, if the bank were to default the pool of securities that underly your investment would be sold by the agent, and you would still be repaid your principal in full. The collateral that is used to secure your investment is recalculated daily to ensure that there is always an adequate level of funding there to cover you in the case of default.
To make this even better, the additional security comes at no cost to the liquidity or yield of your investment. These deposits would be no more or less liquid than a standard unsecured deposit and, despite being more secure, the yields offered are often above that of an unsecured deposit. Although you’d expect secured deposits to offer a lower yield due to their increased security, banks receive regulatory credit for accepting secured deposits which encourages them to offer improved rates. The level of collateral used to secure your investment also has an impact on the yield offered, you can secure your investment on gilts (higher security, lower yield) or on investment grade corporate bonds (lower security, higher yield) of varying degrees of credit. No matter the level of security of the underlying bonds, a secured deposit will always be more secure than an unsecured one.
This trade would essentially be a reverse repo transaction whereby the investor is purchasing collateral with the agreement that you would sell it back at a fixed price at a later date. To do this on your own it would require access to a custody account and provide a decent sized admin burden, but by transacting through our partners, they will take on almost all of the admin. This is a market that has traditionally been difficult for local authorities, charities and companies to access but we have opened it up with our partners acting as a collateral management agent and nominee which greatly simplifies the signup and trading process for investors.
So, with a simple signup process, increased security, bail-in exemption and a higher yield to top it off, secured deposits offer a competitive option for investment when looking to shore up unsecured investment balances.
Please contact us at treasury@arlingclose.com to find out more.
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