Repurchase agreement
Encyclopedia
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities
together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral
for a secured cash loan
at a fixed rate of interest
.
A repo is equivalent to a cash transaction combined with a forward contract
. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price
and the spot price
is effectively the interest on the loan while one of the settlement date
of the forward contract is the maturity
date of the loan.
, with the buyer (effectively the lender or investor) receiving securities as collateral
to protect him against default by the seller. The party who initially sells the securities is effectively the borrower. Almost any security may be employed in a repo, though highly liquid securities are preferred as they are more easily disposed of in the event of a default and, more importantly, they can be easily obtained in the open market where the buyer has created a short position in the repo security by a reverse repo and market sale; by the same token, non liquid securities are discouraged. Treasury or Government bills, corporate and Treasury/Government bonds, and stocks may all be used as "collateral" in a repo transaction. Unlike a secured loan, however, legal title to the securities passes from the seller to the buyer. Coupon
s (interest payable to the owner of the securities) falling due while the repo buyer owns the securities are, in fact, usually passed directly onto the repo seller. This might seem counterintuitive, as the legal ownership of the collateral rests with the buyer during the repo agreement. The agreement might instead provide that the buyer receives the coupon, with the cash payable on repurchase being adjusted to compensate, though this is more typical of sell/buybacks.
Although the transaction is similar to a loan, and its economic effect is similar to a loan, the terminology differs from that applying to loans: the seller legally repurchases the securities from the buyer at the end of the loan term. However a key aspect of repos is that they are legally recognised as a single transaction (important in the event of counterparty insolvency) and not as a disposal and a repurchase for tax purposes.
The following table summarizes the terminology:
Repo transactions occur in three forms: specified delivery, tri-party, and held in custody. The third form is quite rare in developing markets primarily due to risks. The first form requires the delivery of a prespecified bond at the onset, and at maturity of the contractual period. Tri-party essentially is a basket form of transaction, and allows for a wider range of instruments in the basket or pool. Tri-party utilizes a tri-party clearing agent or bank and is a more efficient form of repo transaction.
or international clearing organization
, the tri-party agent, acts as an intermediary between the two parties to the repo. The tri-party agent is responsible for the administration of the transaction including collateral allocation, marking to market, and substitution of collateral. In the US, the two principal tri-party agents are The Bank of New York Mellon and JP Morgan Chase. The size of the US tri-party repo market peaked in 2008 before the worst effects of the crisis at approximately $2.8 trillion and by mid 2010 was about $1.6 trillion.
As tri-party agents administer hundreds of billions of US$ of collateral, they have the scale to subscribe to multiple data feeds to maximise the universe of coverage. As part of a tri-party agreement the three parties to the agreement, the tri-party agent, the repo buyer and the repo seller agree to a collateral management service agreement which includes an "eligible collateral profile". It is this "eligible collateral profile" that enables the repo buyer to define their risk appetite in respect of the collateral that they are prepared to hold against their cash. For example a more risk averse repo buyer may wish to only hold "on-the-run" government bonds as collateral. In the event of a liquidation event of the repo seller the collateral is highly liquid thus enabling the repo buyer to sell the collateral quickly. A less risk averse repo buyer may be prepared to take non investment grade bonds or equities as collateral, which may be less liquid and may suffer a higher price volatility in the event of a repo seller default, making it more difficult for the repo buyer to sell the collateral and recover their cash. The tri-party agents are able to offer sophisticated collateral eligibility filters which allow the repo buyer to create these "eligible collateral profiles" which can systemically generate collateral pools which reflect the buyer's risk appetite. Collateral eligibility criteria could include asset type, issuer, currency, domicile, credit rating, maturity, index, issue size, average daily traded volume, etc. Both the lender (repo buyer) and borrower (repo seller) of cash enter into these transactions to avoid the administrative burden of bi-lateral repos. In addition, because the collateral is being held by an agent, counterparty
risk is reduced. A tri-party repo may be seen as the outgrowth of the due bill repo, in which the collateral is held by a neutral third party.
There are a number of differences between the two structures. A repo is technically a single transaction whereas a sell/buy back is a pair of transactions (a sell and a buy).
A sell/buy back does not require any special legal documentation while a repo generally requires a master agreement to be in place between the buyer and seller (typically the SIFMA/ICMA commissioned Global Master Repo Agreement (GMRA)). For this reason there is an associated increase in risk compared to repo. Should the counterparty default, the lack of agreement may lessen legal standing in retrieving collateral. Any coupon payment on the underlying security during the life of the sell/buy back will generally be passed back to the seller of the security by adjusting the cash paid at the termination of the sell/buy back. In a repo, the coupon will be passed on immediately to the seller of the security.
A buy/sell back is the equivalent of a "reverse repo".
, the purpose is to temporarily obtain the security for other purposes, such as covering short positions or for use in complex financial structures. Securities are generally lent out for a fee and securities lending trades are governed by different types of legal agreements than repos.
Repos have traditionally been used as a form of collateralized loan and have been treated as such for tax purposes. Modern Repo agreements, however, often allow the cash lender to sell the security provided as collateral and substitute an equivalent security at repurchase. In this way the cash lender acts as a security borrower and the Repo agreement can be used to take a short position in the security very much like a security loan might be used.
for repos is good, and rates are competitive for investors. Money Funds
are large buyers of Repurchase Agreements.
For traders in trading firms, repos are used to finance long
positions, obtain access to cheaper funding costs of other speculative investments, and cover short positions in securities.
In addition to using repo as a funding vehicle, repo traders "make markets
". These traders have been traditionally known as "matched-book repo traders". The concept of a matched-book trade follows closely to that of a broker who takes both sides of an active trade, essentially having no market risk, only credit risk. Elementary matched-book traders engage in both the repo and a reverse repo within a short period of time, capturing the profits from the bid/ask spread between the reverse repo and repo rates. Presently, matched-book repo traders employ other profit strategies, such as non-matched maturities, collateral swaps, and liquidity management.
of the Federal Reserve
in open market operations adds reserves
to the banking system and then after a specified period of time withdraws them; reverse repos initially drain reserves and later add them back. This tool can also be used to stabilize interest rates, and the Federal Reserve has used it to adjust the Federal funds rate
to match the target rate
.
Under a repurchase agreement ("RP" or "repo"), the Federal Reserve (Fed) buys U.S. Treasury securities, U.S. agency securities, or mortgage-backed securities
from a primary dealer who agrees to buy them back, typically within one to seven days; a reverse repo is the opposite. Thus the Fed describes these transactions from the counterparty's viewpoint rather than from their own viewpoint.
If the Federal Reserve is one of the transacting parties, the RP is called a "system repo", but if they are trading on behalf of a customer (e.g. a foreign central bank) it is called a "customer repo". Until 2003 the Fed did not use the term "reverse repo"—which it believed implied that it was borrowing money (counter to its charter)—but used the term "matched sale" instead.
can be triggered asking the borrower to post extra securities). Conversely, if the value of the security rises there is a credit risk for the borrower in that the creditor may not sell them back. If this is considered to be a risk, then the borrower may negotiate a repo which is under-collateralized. Credit risk associated with repo is subject to many factors: term of repo, liquidity of security, the strength of the counterparties involved, etc.
Certain forms of Repo transactions came into focus within the financial press due to the technicalities of settlements following the collapse of Refco
in 2005. Occasionally, a party involved in a repo transaction may not have a specific bond at the end of the repo contract. This may cause a string of failures from one party to the next, for as long as different parties have transacted for the same underlying instrument. The focus of the media attention centers on attempts to mitigate these failures.
In 2008, attention was drawn to a form of repo known as repo 105
following the Lehman collapse
, as it was alleged that repo 105s had been used as an accounting trick to hide Lehman's worsening financial health. Another controversial form of repurchase order is the "internal repo" which first came to prominence in 2005. In 2011 is was speculated, though not proven, that internal repos used to finance risky trades in sovereign European bonds may have been the mechanism by which MF Global
lost some several hundred million dollars of client funds, prior to its bankruptcy in October 2011.
and WWII , then expanded once again in the 1950s, enjoying rapid growth in the 1970s and 1980s in part due to computer technology.
In July 2011, concerns arose among bankers and the financial press that if the 2011 U.S. debt ceiling crisis leads to a default it could cause considerable disruption to the repo market. This is because treasuries are the most commonly used collateral within the US repo market, and as a default would downgrade the value of treasuries it could result in repo borrowers having to post far more collateral.
The European repo market has experienced consistent growth over the past five years, from €1.9 billion in 2001 to €6.4 trillion by the end of 2006, and is expected to continue significant growth due to Basel II
, according to a 2007 Celent report entitled “The European Repo Market”.
Especially in the US and to a lesser degree in Europe, the repo market contracted in 2008 as a result of the financial crisis. But by mid 2010 the market had largely recovered and at least in Europe had grown to exceed its pre-crisis peak.
Other countries including Chile, India, Japan, Mexico, Hungary, Russia, China, and Taiwan, have their own repo markets, though activity varies by country, and no global survey or report has been compiled.
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
together with an agreement for the seller to buy back the securities at a later date. The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
for a secured cash loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
at a fixed rate of interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
.
A repo is equivalent to a cash transaction combined with a forward contract
Forward contract
In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed today. This is in contrast to a spot contract, which is an agreement to buy or sell an asset today. It costs nothing to enter a...
. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price
Forward price
The forward price is the agreed upon price of an asset in a forward contract. Using the rational pricing assumption, for a forward contract on an underlying asset that is tradeable, we can express the forward price in terms of the spot price and any dividends etc...
and the spot price
Spot price
The spot price or spot rate of a commodity, a security or a currency is the price that is quoted for immediate settlement . Spot settlement is normally one or two business days from trade date...
is effectively the interest on the loan while one of the settlement date
Settlement date
Settlement Date is a securities industry term describing the date on which a trade settles. That is, the actual day on which transfer of cash or assets is completed....
of the forward contract is the maturity
Maturity (finance)
In finance, maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal is due to be paid....
date of the loan.
Structure and terminology
A repo is economically similar to a secured loanSecured loan
A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan...
, with the buyer (effectively the lender or investor) receiving securities as collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
to protect him against default by the seller. The party who initially sells the securities is effectively the borrower. Almost any security may be employed in a repo, though highly liquid securities are preferred as they are more easily disposed of in the event of a default and, more importantly, they can be easily obtained in the open market where the buyer has created a short position in the repo security by a reverse repo and market sale; by the same token, non liquid securities are discouraged. Treasury or Government bills, corporate and Treasury/Government bonds, and stocks may all be used as "collateral" in a repo transaction. Unlike a secured loan, however, legal title to the securities passes from the seller to the buyer. Coupon
Coupon (bond)
A coupon payment on a bond is a periodic interest payment that the bondholder receives during the time between when the bond is issued and when it matures. Coupons are normally described in terms of the coupon rate, which is calculated by adding the total amount of coupons paid per year and...
s (interest payable to the owner of the securities) falling due while the repo buyer owns the securities are, in fact, usually passed directly onto the repo seller. This might seem counterintuitive, as the legal ownership of the collateral rests with the buyer during the repo agreement. The agreement might instead provide that the buyer receives the coupon, with the cash payable on repurchase being adjusted to compensate, though this is more typical of sell/buybacks.
Although the transaction is similar to a loan, and its economic effect is similar to a loan, the terminology differs from that applying to loans: the seller legally repurchases the securities from the buyer at the end of the loan term. However a key aspect of repos is that they are legally recognised as a single transaction (important in the event of counterparty insolvency) and not as a disposal and a repurchase for tax purposes.
The following table summarizes the terminology:
| Repo | Reverse repo | |
|---|---|---|
| Participant | Borrower Seller Cash receiver |
Lender Buyer Cash provider |
| Near leg | Sells securities | Buys securities |
| Far leg | Buys securities | Sells securities |
Types of repo and related products
There are three types of repo maturities: overnight, term, and open repo. Overnight refers to a one-day maturity transaction. Term refers to a repo with a specified end date. Open simply has no end date. Although repos are typically short-term, it is not unusual to see repos with a maturity as long as two years.Repo transactions occur in three forms: specified delivery, tri-party, and held in custody. The third form is quite rare in developing markets primarily due to risks. The first form requires the delivery of a prespecified bond at the onset, and at maturity of the contractual period. Tri-party essentially is a basket form of transaction, and allows for a wider range of instruments in the basket or pool. Tri-party utilizes a tri-party clearing agent or bank and is a more efficient form of repo transaction.
Due bill/hold in-custody repo
In a due bill repo, the collateral pledged by the (cash) borrower is not actually delivered to the cash lender. Rather, it is placed in an internal account ("held in custody") by the borrower, for the lender, throughout the duration of the trade. This has become less common as the repo market has grown, particularly owing to the creation of centralized counterparties. Due to the high risk to the cash lender, these are generally only transacted with large, financially stable institutions.Tri-party repo
The distinguishing feature of a tri-party repo is that a custodian bankCustodian bank
A Custodian bank, or simply custodian, is a specialized financial institution responsible for safeguarding a firm's or individual's financial assets and is not likely to engage in "traditional" commercial or consumer/retail banking such as mortgage or personal lending, branch banking, personal...
or international clearing organization
Clearing house (finance)
A clearing house is a financial institution that provides clearing and settlement services for financial and commodities derivatives and securities transactions...
, the tri-party agent, acts as an intermediary between the two parties to the repo. The tri-party agent is responsible for the administration of the transaction including collateral allocation, marking to market, and substitution of collateral. In the US, the two principal tri-party agents are The Bank of New York Mellon and JP Morgan Chase. The size of the US tri-party repo market peaked in 2008 before the worst effects of the crisis at approximately $2.8 trillion and by mid 2010 was about $1.6 trillion.
As tri-party agents administer hundreds of billions of US$ of collateral, they have the scale to subscribe to multiple data feeds to maximise the universe of coverage. As part of a tri-party agreement the three parties to the agreement, the tri-party agent, the repo buyer and the repo seller agree to a collateral management service agreement which includes an "eligible collateral profile". It is this "eligible collateral profile" that enables the repo buyer to define their risk appetite in respect of the collateral that they are prepared to hold against their cash. For example a more risk averse repo buyer may wish to only hold "on-the-run" government bonds as collateral. In the event of a liquidation event of the repo seller the collateral is highly liquid thus enabling the repo buyer to sell the collateral quickly. A less risk averse repo buyer may be prepared to take non investment grade bonds or equities as collateral, which may be less liquid and may suffer a higher price volatility in the event of a repo seller default, making it more difficult for the repo buyer to sell the collateral and recover their cash. The tri-party agents are able to offer sophisticated collateral eligibility filters which allow the repo buyer to create these "eligible collateral profiles" which can systemically generate collateral pools which reflect the buyer's risk appetite. Collateral eligibility criteria could include asset type, issuer, currency, domicile, credit rating, maturity, index, issue size, average daily traded volume, etc. Both the lender (repo buyer) and borrower (repo seller) of cash enter into these transactions to avoid the administrative burden of bi-lateral repos. In addition, because the collateral is being held by an agent, counterparty
Counterparty
A counterparty is a legal and financial term. It means a party to a contract. A counterparty is usually the entity with whom one negotiates on a given agreement, and the term can refer to either party or both, depending on context....
risk is reduced. A tri-party repo may be seen as the outgrowth of the due bill repo, in which the collateral is held by a neutral third party.
Whole loan repo
A whole loan repo is a form of repo where the transaction is collateralized by a loan or other form of obligation (e.g. mortgage receivables) rather than a security.Equity repo
The underlying security for many repo transactions is in the form of government or corporate bonds. Equity repos are simply repos on equity securities such as common (or ordinary) shares. Some complications can arise because of greater complexity in the tax rules for dividends as opposed to coupons.Sell/buy backs and buy/sell backs
A sell/buy back is the spot sale and a forward repurchase of a security. It is two distinct outright cash market trades, one for forward settlement. The forward price is set relative to the spot price to yield a market rate of return. The basic motivation of sell/buy backs is generally the same as for a classic repo, i.e. attempting to benefit from the lower financing rates generally available for collateralized as opposed to non-secured borrowing. The economics of the transaction are also similar with the interest on the cash borrowed through the sell/buy back being implicit in the difference between the sale price and the purchase price.There are a number of differences between the two structures. A repo is technically a single transaction whereas a sell/buy back is a pair of transactions (a sell and a buy).
A sell/buy back does not require any special legal documentation while a repo generally requires a master agreement to be in place between the buyer and seller (typically the SIFMA/ICMA commissioned Global Master Repo Agreement (GMRA)). For this reason there is an associated increase in risk compared to repo. Should the counterparty default, the lack of agreement may lessen legal standing in retrieving collateral. Any coupon payment on the underlying security during the life of the sell/buy back will generally be passed back to the seller of the security by adjusting the cash paid at the termination of the sell/buy back. In a repo, the coupon will be passed on immediately to the seller of the security.
A buy/sell back is the equivalent of a "reverse repo".
Securities lending
In securities lendingSecurities lending
In finance, securities lending or stock lending refers to the lending of securities by one party to another. The terms of the loan will be governed by a "Securities Lending Agreement", which requires that the borrower provides the lender with collateral, in the form of cash, government securities,...
, the purpose is to temporarily obtain the security for other purposes, such as covering short positions or for use in complex financial structures. Securities are generally lent out for a fee and securities lending trades are governed by different types of legal agreements than repos.
Repos have traditionally been used as a form of collateralized loan and have been treated as such for tax purposes. Modern Repo agreements, however, often allow the cash lender to sell the security provided as collateral and substitute an equivalent security at repurchase. In this way the cash lender acts as a security borrower and the Repo agreement can be used to take a short position in the security very much like a security loan might be used.
Reverse Repo
A reverse repo is simply the same repurchase agreement from the buyer's viewpoint, not the seller's. Hence, the seller executing the transaction would describe it as a "repo", while the buyer in the same transaction would describe it a "reverse repo". So "repo" and "reverse repo" are exactly the same kind of transaction, just described from opposite viewpoints. The term "reverse repo and sale" is commonly used to describe the creation of a short position in a debt instrument where the buyer in the repo transaction immediately sells the security provided by the seller on the open market. On the settlement date of the repo, the buyer acquires the relevant security on the open market and delivers it to the seller. In such a short transaction the seller is wagering that the relevant security will decline in value between the date of the repo and the settlement date.Uses
For the buyer, a repo is an opportunity to invest cash for a customized period of time (other investments typically limit tenures). It is short-term and safer as a secured investment since the investor receives collateral. Market liquidityMarket liquidity
In business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
for repos is good, and rates are competitive for investors. Money Funds
Money fund
A money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely regarded as being as safe as bank deposits yet providing a higher yield...
are large buyers of Repurchase Agreements.
For traders in trading firms, repos are used to finance long
Long (finance)
In finance, a long position in a security, such as a stock or a bond, or equivalently to be long in a security, means the holder of the position owns the security and will profit if the price of the security goes up. Going long is the more conventional practice of investing and is contrasted with...
positions, obtain access to cheaper funding costs of other speculative investments, and cover short positions in securities.
In addition to using repo as a funding vehicle, repo traders "make markets
Market maker
A market maker is a company, or an individual, that quotes both a buy and a sell price in a financial instrument or commodity held in inventory, hoping to make a profit on the bid-offer spread, or turn. From a market microstructure theory standpoint, market makers are net sellers of an option to be...
". These traders have been traditionally known as "matched-book repo traders". The concept of a matched-book trade follows closely to that of a broker who takes both sides of an active trade, essentially having no market risk, only credit risk. Elementary matched-book traders engage in both the repo and a reverse repo within a short period of time, capturing the profits from the bid/ask spread between the reverse repo and repo rates. Presently, matched-book repo traders employ other profit strategies, such as non-matched maturities, collateral swaps, and liquidity management.
United States Federal Reserve use of repos
Repurchase agreements when transacted by the Federal Open Market CommitteeFederal Open Market Committee
The Federal Open Market Committee , a committee within the Federal Reserve System, is charged under United States law with overseeing the nation's open market operations . It is the Federal Reserve committee that makes key decisions about interest rates and the growth of the United States money...
of the Federal Reserve
Federal Reserve System
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...
in open market operations adds reserves
Bank reserves
Bank reserves are banks' holdings of deposits in accounts with their central bank , plus currency that is physically held in the bank's vault . The central banks of some nations set minimum reserve requirements...
to the banking system and then after a specified period of time withdraws them; reverse repos initially drain reserves and later add them back. This tool can also be used to stabilize interest rates, and the Federal Reserve has used it to adjust the Federal funds rate
Federal funds rate
In the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend...
to match the target rate
Inflation targeting
Inflation targeting is an economic policy in which a central bank estimates and makes public a projected, or "target", inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools.Because interest rates and the...
.
Under a repurchase agreement ("RP" or "repo"), the Federal Reserve (Fed) buys U.S. Treasury securities, U.S. agency securities, or mortgage-backed securities
Mortgage-backed security
A mortgage-backed security is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.-Securitization:...
from a primary dealer who agrees to buy them back, typically within one to seven days; a reverse repo is the opposite. Thus the Fed describes these transactions from the counterparty's viewpoint rather than from their own viewpoint.
If the Federal Reserve is one of the transacting parties, the RP is called a "system repo", but if they are trading on behalf of a customer (e.g. a foreign central bank) it is called a "customer repo". Until 2003 the Fed did not use the term "reverse repo"—which it believed implied that it was borrowing money (counter to its charter)—but used the term "matched sale" instead.
Risks
While classic repos are generally credit-risk mitigated instruments, there are residual credit risks. Though it is essentially a collateralized transaction, the seller may fail to repurchase the securities sold at the maturity date. In other words, the repo seller defaults on his obligation. Consequently, the buyer may keep the security, and liquidate the security in order to recover the cash lent. The security, however, may have lost value since the outset of the transaction as the security is subject to market movements. To mitigate this risk, repos often are over-collateralized as well as being subject to daily mark-to-market margining (i.e. if the collateral falls in value, a Margin callMargin Call
Margin Call is a 2011 American independent drama film, written and directed by J.C. Chandor. The film has an ensemble cast that includes Kevin Spacey, Demi Moore, Paul Bettany, Jeremy Irons, Zachary Quinto, Stanley Tucci, Simon Baker, and Penn Badgley...
can be triggered asking the borrower to post extra securities). Conversely, if the value of the security rises there is a credit risk for the borrower in that the creditor may not sell them back. If this is considered to be a risk, then the borrower may negotiate a repo which is under-collateralized. Credit risk associated with repo is subject to many factors: term of repo, liquidity of security, the strength of the counterparties involved, etc.
Certain forms of Repo transactions came into focus within the financial press due to the technicalities of settlements following the collapse of Refco
Refco
Refco was a New York-based financial services company, primarily known as a broker of commodities and futures contracts. It was founded in 1969 as "Ray E. Friedman and Co." Prior to its collapse in October, 2005, the firm had over $4 billion in approximately 200,000 customer accounts, and it was...
in 2005. Occasionally, a party involved in a repo transaction may not have a specific bond at the end of the repo contract. This may cause a string of failures from one party to the next, for as long as different parties have transacted for the same underlying instrument. The focus of the media attention centers on attempts to mitigate these failures.
In 2008, attention was drawn to a form of repo known as repo 105
Repo 105
Repo 105 is a repurchase agreement which results in an accounting maneuver where a short-term loan is classified as a sale. The cash obtained through this "sale" is then used to pay down debt, allowing the company to appear to reduce its leverage by temporarily paying down liabilities—just long...
following the Lehman collapse
Bankruptcy of Lehman Brothers
Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. The bankruptcy of Lehman Brothers remains the largest bankruptcy filing in U.S...
, as it was alleged that repo 105s had been used as an accounting trick to hide Lehman's worsening financial health. Another controversial form of repurchase order is the "internal repo" which first came to prominence in 2005. In 2011 is was speculated, though not proven, that internal repos used to finance risky trades in sovereign European bonds may have been the mechanism by which MF Global
MF Global
MF Global , formerly known as Man Financial, was a major global financial derivatives broker. MF Global provided exchange-traded derivatives, such as futures and options as well as over-the-counter products such as contracts for difference , foreign exchange and spread betting. MF Global was...
lost some several hundred million dollars of client funds, prior to its bankruptcy in October 2011.
History
In the US, Repos have been used from as early as 1917 when war time taxes made older forms of lending less attractive. At first Repos were used just by the Federal reserve to lend to other banks, but the practice soon spread to other market participants. The use of Repos expanded in the 1920s, fell away through the Great depressionGreat Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...
and WWII , then expanded once again in the 1950s, enjoying rapid growth in the 1970s and 1980s in part due to computer technology.
In July 2011, concerns arose among bankers and the financial press that if the 2011 U.S. debt ceiling crisis leads to a default it could cause considerable disruption to the repo market. This is because treasuries are the most commonly used collateral within the US repo market, and as a default would downgrade the value of treasuries it could result in repo borrowers having to post far more collateral.
Market size
The US Federal Reserve and the European Repo Council (a body of the International Capital Market Association) both try to estimate the size of their respective repo markets. At the end of 2004, the U.S. repo market reached US$5 trillion.The European repo market has experienced consistent growth over the past five years, from €1.9 billion in 2001 to €6.4 trillion by the end of 2006, and is expected to continue significant growth due to Basel II
Basel II
Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision...
, according to a 2007 Celent report entitled “The European Repo Market”.
Especially in the US and to a lesser degree in Europe, the repo market contracted in 2008 as a result of the financial crisis. But by mid 2010 the market had largely recovered and at least in Europe had grown to exceed its pre-crisis peak.
Other countries including Chile, India, Japan, Mexico, Hungary, Russia, China, and Taiwan, have their own repo markets, though activity varies by country, and no global survey or report has been compiled.
Repo and Reverse Repo in India
In India, RBI uses Repo and reverse repo technique for increase or decrease the liquidity in the market. For increases liquidity, RBI buys govt. securities from banks under REPO and for decreasing the liquidity, RBI sells the govt. securities to banks. http://www.svtuition.org/2011/11/repo-and-reverse-repo.htmlSee also
- Collateral managementCollateral ManagementCollateral has been used for hundreds of years to provide security against the possibility of payment default by the opposing party in a trade. Collateral management began in the 1980s, with Bankers Trust and Salomon Brothers taking collateral against credit exposure. There were no legal standards,...
- Currency swapCurrency swapA currency swap is a foreign-exchange agreement between two parties to exchange aspects of a loan in one currency for equivalent aspects of an equal in net present value loan in another currency; see foreign exchange derivative. Currency swaps are motivated by comparative advantage...
- Discount rateDiscount rateThe discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window....
- Discount windowDiscount windowThe discount window is an instrument of monetary policy that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions...
- Dollar rollDollar RollA dollar roll is similar to a reverse repurchase agreement. The investor sells a mortgage-backed security for settlement on one date and buys it back for settlement at a later date. The investor gives up the principal and interest payments during the roll period but can invest the proceeds and...
- Federal fundsFederal fundsIn the United States, federal funds are overnight borrowings by banks to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear financial transactions...
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- Money marketMoney marketThe money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit,...
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