Could Bitcoin become a repo asset? In our first edition of the CLST Talks, we sit together with Thomas Maurer at our office in Zurich to talk about all things money markets, new money markets and his overall view on the role digital assets play in the new era of financial services. Below you can enjoy the transcribed interview between Thomas Maurer, Bara Caldova and CLST CEO, Michael Guzik.
About Thomas Maurer
With over 40 years of experience, Thomas Maurer is a true veteran in the field of money markets. He started his career in 1982 doing foreign exchange (FX options and FX forwards), while slowly transitioning into cash and derivative money markets products that were just about to emerge in the 1990ties. He then went on to become group treasurer at Julius Bär. In this position, he was a market maker for interest rate derivatives. After a quick liaison with Vontobel, Maurer moved back to Julius Bär, taking over the role as the Global Head Interest Rate Competence Center and Member of the Groups Asset & Liability Investment Committee his last function at the bank. Thomas won the Swiss derivative award for the best money market product in 2013, 2016, and 2017. Today, he is working for Convexis Group as CIO and partner. Convexis offers money market solutions (short-term securities with a fixed tenor and guaranteed yield) to investors around the globe. His connection to CLST is that of a key opinion leader – he regularly exchanges knowledge with the team regarding interest rate markets.
Part 1 – Early Days of Money Markets
What was your experience with money markets back in the day?
Interbank borrowing and lending were based on fax machines, telephones, Reuters Dealing, and voice brokers. It is only a few years since money markets got disrupted by money market platforms like Instimatch. At Julius Bär, we were quoting prices to banks and brokers alike for cash and derivatives. A voice broker on the other hand would have a network of 70 – 100 other banks that he would contact to get him the best price for a three-month deposit or a forward rate agreement (FRA).
As we understand you, these early days were plagued by inefficiency and intransparency.
Indeed. That is why I also took on the role of being a member of the advisory working group for the Swiss National Bank and was particularly excited when they implemented the SWX repo platform in 1998/98.
Would you say that the platform’s goal was to introduce efficiency and transparency into the repo lending process?
Well, the Swiss National Bank implemented a repo market because they only wanted to have secured lending and borrowing to avoid any systematic risks. Before the SWX platform was implemented, repo trading was a huge mess. Everyone was just doing bilateral repo agreements that were rather difficult to smoothly pull off because of all the different contracts, legal technicalities, and missing valuation models for collateral. Fortunately, they managed to standardize the platform into the SWX platform, a crucial step.
Was the Swiss National Bank the first central bank to do this?
Yes. At the time, the Swiss platform was way ahead. The platform was perfect: I could lend you money and get the collateral booked into my account immediately (through SEGA). Thanks to what is called Swiss Annex contracts, triparty repo became possible. Everyone could trade with one another through a standardized legal contract backing the trade. With such an innovation at hand, the question for the Swiss National bank was: How to convince everyone to use this platform? My function was to go around convincing other treasurers of using this freshly implemented repo facility.
How successful was this approach and how successful was the platform in the end?
In the end, I’d say that the strategy of the SNB was rather successful. The number of members on the SNB SWX platform grew from 4 to 70 within 2 years. The Swiss National Bank had its clever tricks: They gave money at 2% to banks that were trading on the platform whereas the market for unsecured borrowing stood at 2.8%. Instead of paying 2.8% on the market, you could borrow with the SNB at only 2% using the Swiss National Bank’s platform. Suddenly everyone wanted to get in on the action until the spread narrowed. It’s a pity that many banks still took the risk to lend unsecured or against low-quality collateral to get a higher rate. We all know what happened as a consequence of this.
Part 2 – Digital assets and banking
What is your connection to the digital asset space?
I first got introduced to Bitcoin through my son. It was in 2011/12 when he told me something about Bitcoin. At that time, I wasn’t taking it very seriously of course. How could I as a serious banker? Then, maybe in 2016/17, when we saw Bitcoin’s first real price jump, I started getting more into the details trying to understand what Bitcoin is.
What conclusion did you come to?
After studying it a bit more I concluded that this cryptocurrency might not be so bad after all. What the last few years have shown me is that you must stay very flexible in your mind and must be willing to adapt to new things all the time – something I recommend to everybody in the financial industry.
Does this mean that you actually bought some Bitcoin?
Well, I wanted to invest some money into Bitcoin to familiarize myself with its technology, but I was too afraid of losing my private keys. In the end, I decided that it might be better for me to buy Bitcoin through one of the Bitcoin certificates, which were offered by other banks. And although the fees were rather high, I looked at them as a sort of premium I was willing to pay for the security of not losing my Bitcoin.
Would you say you are as of today a believer in crypto?
I would not call myself a believer today – not by any stretch of the imagination – but I can see the pros of Bitcoin and other crypto assets. I consider myself a neutral market observer, one that even wanted to issue a diversified, actively managed certificate consisting of a basket with five different cryptocurrencies. However, when we presented this product to our management of the bank, we were put off as they did not want any cryptocurrency product to counteract the bank’s efforts in the field of anti-money laundering. We ended up not launching the product. I guess the timing just wasn’t right and we were too early.
Has the bank’s stance towards cryptocurrencies changed in the meantime?
From what I have heard from my colleagues at different banks, they’ve had some professional clients but there is still a long way to standardizing everything the proper way to meet institutional needs.
Asking the treasurer in you: How do cryptocurrencies fit a treasurer’s perspective as of today?
First, if a bank wants to hold a cryptocurrency, the capital requirements to do so are very high. A bank that wants to hold Bitcoin on its books must adhere to a risk weighting of up to 1250. As the bank must hold 8% in the form of capital under Basel III that means that for each dollar in Bitcoin that the bank holds, one US dollar in capital is needed. This makes holding Bitcoin enormously expensive.
So, what about banks that issue Bitcoin certificates?
Because of the risk weighting applied, for 100 USD in Bitcoin, they must hold up to 100 USD in capital. Because the bank must hold this much in capital, while their return on equity is supposed to be 10%, the margin required is a minimum of 10% to turn a profit. In the end, this makes launching such a product hard because you would have to charge 10%, which is not possible. All in all, this means that for banks to hold Bitcoin, it is very expensive to do so. As it stands, this high-risk weighting is the main hurdle for banks to hold Bitcoin or any other crypto asset as a treasury asset.
How have banks managed to keep their Bitcoin certificates anyway?
I can only assume that their Bitcoin positions are held in a segregated account to reduce the risk weighting – also banks are handling this differently from bank to bank.
Do you think that these capital requirements will loosen up?
In the context of cryptocurrencies, I don’t think so. After all, the risk weighting is dependent on the volatility and security of an asset. For example, if a bank holds AAA government bonds, the risk weighting is zero. No capital needs to be held against. If a bank invests in money markets with an OECD bank, the risk weighting elevates to 20%. Still, this is much lower than for Bitcoin. The point is: Banks always must calculate what their return on equity is to see whether it is worthwhile or not.
Part 3 – Stablecoins in the money market space
How do you perceive stablecoins through the lens of a conventional treasurer?
A stablecoin might be more interesting if I know exactly who is behind it and what is backing it. A stablecoin, whose assets are entirely made up of treasury bonds has an altogether different risk weighting than a stablecoin that has invested in unsecured deposits. With the latter, the cost of capital will be high resulting in a high-risk weighting.
Why is this so?
It all comes down to the expected loss. The expected loss on Swiss government bonds is zero. The expected loss on Italian bonds is 2 or 3 percent in the short term. Therefore, it is very important to know what a project (stablecoin or not) has invested in and holds on its balance sheet to back the coins issued. So, when it comes to stablecoins then: They could potentially be interesting from a treasurer’s viewpoint, but it all depends on what is it backed by. At the same time, there also needs to be a credible way to truly verify that the backing is what it is.
What do you think is needed to close the gap between stablecoin and conventional cash to enable new money markets?
To become a proper form of cash, you will have to have stablecoins invest in fiat money as their backing, which is sort of ironical. Also, professional auditing will be very important similar to the reporting in today’s money market funds. What are the positions, where is it invested, and what is the weighting average of the maturities? Where is the custodian? One of the big four needs to make a statement. Anti-money laundering standards will have to be followed and the client’s due diligence will be very important. But there is also a practical challenge in today’s changing environment.
When interest rates were near zero, there was no great opportunity cost of having a stablecoin keeping their investments at a bank – unsecured and exposed to credit risk. With rising rates, we see the trend going to US treasuries. Thus, it does not make sense to invest in stablecoins that don’t pay a yield. I assume it is only a question of time until stablecoins like USDC must pass part of the interest income onto holders. Once we see this shift, I can encourage people to hold stablecoins.
Looking into the future: Do you see stablecoins and CBDCs coexisting?
Central bank digital currencies are subject to a size limitation. This is because central banks don’t want to disrupt the banks’ businesses. The existence of a retail central bank digital currency could easily disrupt commercial banks in times of a financial crisis. Banks would lose their refinancing possibilities (liabilities) within a few days as people would move to the secure CBDC in a bank run.
Let us assume a stablecoin becomes widely accepted; a de facto synthetic CBDC, what implications do you foresee on the commercial terms side of the credit market?
If there would be an unlimited synthetic CBDC, banks would lose their cheap way of refinancing themselves as they would need to attract refinancing by paying up for their liabilities. Given such a situation, the pricing for borrowing on the part of bank customers would also increase to a level where nobody could or would take any credit anymore from a bank as it would be too expensive – in other words, the bank’s business model would be disrupted.
Are stablecoins of interest to banks?
I would argue they are not because the bank rather keeps the cash coming from clients on its balance sheet. After all, a bank needs cash to refinance its assets. Thus, I would conclude that a banker will never promote stablecoins to his clients.
So, you believe banks will never deal with stablecoin then?
While they would not adopt stablecoins themselves, the market is nevertheless pushing them to do so anyway sooner or later. It is not the central banks’ job to support profits from banks. The clients’ pressure will make them accept stablecoins instead of money market products. They won’t be able to prevent this, although banks are trying everything to avoid it.
Could you foresee banks entering into agent lending services or agent investment services with Bitcoin or USDC invested on behalf of their clients?
A type of securities lending banks will sooner or later have to engage in. This will come in the form of either a securities or repo lending format. Already today, clients are approaching their bank asking them to do some lending or staking on their behalf.
Part 4 – Bitcoin and repo markets
How do you perceive the adoption of Bitcoin as a commodity among treasurers?
More and more treasurers from traditional banking are moving over into the crypto space. With them, the relevant know-how is transferred as well. In addition, we are seeing crypto assets being incorporated into the research of traditional banks, which further encourages portfolio managers to consider these new assets. Once digital assets are part of a bank’s portfolio management, treasurers will have to care as well because clients might be interested in using their assets in one way or another.
Do you believe BTC could become a repo-able asset?
Doing a repo transaction with Bitcoin would not represent a normal repo but a special repo.
What does this mean exactly?
In a normal repo, you are given cash against a general basket of collateral. Bitcoin on the other hand is just one asset, so it would be part of a special repo that is just going back to one reference instead of a basket of many different assets. A special repo is also conducted by a bank that is short a specific bond. The bank then must ask other banks whether they have booked this special bond in their basket.
Could Bitcoin be part of a basket?
Yes. Bitcoin could be part of a general cryptocurrency basket. Or there could be a basket consisting of bonds, cash, and a little bit of Bitcoin. Every asset would just be calculated differently.
Let us imagine a world where a treasurer would want to engage in a Repo transaction by accepting Bitcoin as collateral. Do you see any structural challenges to such a scenario?
Structurally there are no issues to accept crypto assets like Bitcoin as a repo. It is just all about the price. Also, it must be made bankable. There will need to be an institutional infrastructure to have the proper reporting in place.
Do you think we see repo lending happening with Bitcoin anytime soon?
It will happen, but it will be not that much of a big business. As a treasurer, I currently don’t have that much interest in doing repo with Bitcoin because it is highly volatile. The haircut I would demand would be 50% or more. I give you one hundred and you give me one hundred and fifty of said collateral. This is rather collateral inefficient.
What about liquidity?
As a treasurer, I also care about liquidity and slippage. How do I get my liquidity and how fast? What is the slippage? Especially when I have to disinvest. At what price do I start and what price do I end up with? You always must know how deep the market is, when and where can I get it, and what will happen if everyone is doing the same. One benefit of Bitcoin is that it is tradable 24 hours. I don’t have the gap risk that overnight the prices will be different.
What about securities lending with Bitcoin? Could this trend emerge?
Securities lending seems like the bigger opportunity for banks in coordination with their clients. When a client opens his account, the bank can just give him the securities lending agreement. This way the client can be made aware that he is about to lend out his cryptocurrencies and get a few basis points in margin. Some of the clients will sign this agreement, others won’t. But this is a standard that needs to happen with cryptocurrencies.
Why sec lending? And what is the difference to repo lending?
If somebody is short an asset, this someone can borrow the asset from me. The lender is getting a fee, which the borrowers have to pay. Sec lending is more of an open-end transaction. You can also terminate this sec lending immediately. With cryptocurrencies, the fees borrowers would have to pay to borrow the assets would just be very high, I assume.
There would need to exist platforms/systems that could provide sec-lending type opportunities. And for the traders on this platform, would need to know their counterparty. Whom am I trading with? Do I have reputational risk? KYC is something, which is very important.
Thomas – thank you for your time and for your insights! We look forward to expanding further on these topics in the future.
Thank you for having me, always a pleasure!
Interview conducted in July 2022 in Zurich by Bara Caldova, Michael Guzik and interview co-written by Pascal Hügli.