Total Return Swap
A Total Return Swap (TRS) is a trade that is economically identical to a repo. The main difference is that the transaction is typically governed by the International Swap Dealers' Association (ISDA) swap agreement. This may alter the way in which the transaction is reflected on an institution's balance sheet and afford additional netting possibilities.
The TRS may be applied to any underlying asset but is most commonly used with equity indices, single stocks, bonds and defined portfolios of loans and mortgages. The TRS or TRORS (Total Rate of Return Swap) is a mechanism for the user to accept the economic benefits of asset ownership without utilising the balance sheet. The other leg of the swap, usually LIBOR, is spread to reflect the non-balance sheet nature of the product. A TRS can be designed with any underlying asset agreed between two parties. It is important to note that no notional amounts are exchanged with a TRS.
The transaction works as follows:
a. Institution sells security at the market price
b. Institution executes a swap transaction for a fixed term, exchanging the total return on the security for an agreed rate on the relevant cash amount
c. Upon maturity of the swap, the institution repurchases the security at the market price
The TROR payer is the legal owner of the reference asset. For the period of the transaction, the latter has created a short position in the market risk and a short position in the credit risk of the reference asset.
The TROR receiver is not the legal owner of the reference asset. The TRS is an off-balance sheet transaction and the reference asset does not appear on the balance sheet of the receiver. For the period of the transaction only, the TROR receiver has a synthetic long position in the market risk and in the credit risk of the reference asset.
As mentioned earlier, under a TRS an asset such as a bond position may be removed from the balance sheet. In order to avoid adverse impact on regular internal and external capital and credit exposure reporting a bank may use TRS to reduce the amount of lower-quality assets on the balance sheet. This can be done by entering into a short-term TRS with a two-week term that straddles the reporting date.
For a detailed presentation pack on TRS please contact your UBS repo relationship manager.
