When confidence is lost, liquidity absquatulates hence, the phraseology that ‘’capital flight to safe havens’’. This article espouses the haircut on investment and investors’ hairstyle amongst others in Ghana, focusing on the sale and repurchase agreements’ kind of investment (repo).
REPO is a kind of money for organizational investors and non-financial firms who require ways to safely store cash and earn some interest. In a repo transaction, a depositor lodges cash and cash equivalent at a financial institution and receives collateral, valued at market prices. The transaction is within a short period, so the depositor can withdraw the money at any time. The deposit is supported by the bonds received as collateral from the institution where the money is deposited. The bonds that the depositor receives can be spent in that they can be used as collateral in another, unrelated, transaction. Example, the bonds could be posted as collateral against a derivatives position. The reuse of collateral is known as rehypothecation. There may be overcollateralization if the market value of the bonds received exceeds the deposit. For instance, if 80 million cedis is lodged and 100 million cedis of bonds are received, then there is a haircut or initial margin of 20 percent. This is akin to bank capital or a reserve fund as the 20 percent is junior in seniority to the depositor’s 80 percent claim.
But what at all is a haircut, and does it have historical antecedents?
Haircut encompasses the difference between the present market value of an asset and the worth ascribed to that asset for purposes of calculating regulatory capital or loan collateral. The quantum of the haircut depicts the perceived risk of the asset falling in value in an immediate cash sale or liquidation. The larger the risk or volatility of the asset price, the larger the haircut. Therefore, a securities and exchange commission that is largely safe with highly liquid assets is likely to have no or lower haircut, compared to a volatile or less marketable assets as the case might be in emerging economies such as Ghana. Well, its basic meaning as espoused by the Hon. Minister of Finance, Ken Ofori -Atta connotes a debt operation bothering on terms of payment of principal and interest on public debt (government bonds) aimed at ensuring debt sustainability.
The concept of haircut initially originated in the US Securities and Exchange Commission in 1967 to explain the ‘’net capital rule.”
Lower haircuts allow for more leverage. Haircut plays indispensable role in several spheres of trades, such as repurchase agreements (referred to in debt-instrument finance as “repo” but not to be bamboozled with the term repossession as used in consumer finance) and reverse repurchase agreements (“reverse repo” in debt-instrument finance) . ‘’NOVDEC’’ revision on Ghana’s debt to GDP shows that, as of December 13, 2022, the Debt to GDP stood at 450 billion cedis, representing 90.7% as compared to 82.1% and 79.1% in 2021 and 2020 resultantly.
Purpose of haircut
The fundamental essence of haircut is to provide a margin of safety against losses incurred by a broker or dealer as a consequent of market fluctuations in the prices of such securities or future commodity contracts. Safe to add that, with respect Ghana, our intended goal of haircut is to ensure debt sustainability levels.
Implications of the Haircut in Emerging Capital Markets
The announcement of haircut without adequate public education would definitely lead to panic withdrawals, occasioned by lack of confidence in the market. This would mean financial intermediaries would lose billions of cedis attributable to the panic withdrawals. With time, financial intermediaries would struggle to meet demands by deficit fund holders, cutting supply of money to borrowers or better still, making it expensive since there are virtually inadequate financial resources to cater for high demand for cash and cash equivalents. This could adversely cripple the banking sector and affect employment therein.
Secondly, with no confidence in the stock market, most surplus fund holders could reverse to keeping their monies in ‘’pillows’’ or elsewhere, and this could also increase petty theft or robberies. There must be intensive public education to address the virgin misconception that ‘’haircut means any money you keep in the bank will lose initial margin.
The announcement of haircut by the Hon. Minister of Finance of Finance without adequate dialogue with surplus fund holders will make investors lose confidence in the regulatory framework of investment in Ghana. Of course, investment is a two-way affair, the surplus fund holder and the intermediary. In investment contract, it becomes problematic for one party, such as the Hon. Minister of Finance to stampede haircut decisions on investors without holistic agreement. Every investor needs a guarantee of his investment hence, the saying ‘’capital flight to safe havens’’. Investment contract is not a standard form contract (take it or leave it kind of contract; where the terms of the contract are determined by one party only) hence, the faultily decision of the Hon. Minister of Finance.
Suffice to say that, investors must have a say as to the kind of hairstyles they want. Especially in our cultural setup, some hairstyles are deemed inapt, rude and disrespectful. Therefore, when the barber (Hon. Minister of Finance) makes it compulsory for investors to accept a given form of hairstyle (haircut) without adequate legal advice by the government law (Attorney General) as well as acceptance by the investors, the reprisal losses on the investment market may soon be indeterminable. Investors must also appreciate the fact that, if the macroeconomic variables are not stable, it will not be safe to invest. One sure way of ensuring a safety investment environment, is to ensure debt sustainability through plausible ways like haircut. Haircut is thus, a necessary evil for the government and investors hence, the need for consensus!
Author: Ephraim Armstrong Awinbugri
The author is a chartered accountant and a chartered financial analyst and could be reached on firstname.lastname@example.org