Gets Confusing Fast: A Review of the GCF Repo[R] Service. (Interest Rate Swaps)

Article excerpt

If terms like "CUSIP," "reversing in," "non-inter-dealer broker netting members," and "tn-party-like settlement" have kept you from taking advantage of a relatively safe, flexible, short-term funding source, spend a few minutes to learn how to benefit from repos and their promise of modern netting and settlement techniques, real-time trade input, and operational and legal innovation.

Repurchase agreements (repos)--commonly used by a variety of entities to meet short-term financing needs--represent a significant segment of the overall U.S. government securities marketplace. (1) Borrowing money by "repoing out" securities can be desirable in a number of instances, such as when repo money is cheaper than buying fed funds or when a long-term borrower believes that the cost of borrowing money will rise. The repo desk at a dealer firm typically uses repos as a means of financing the firm's inventory and long trading positions in government securities because repos offer a high degree of safety, are administratively easy to process, and have relatively flexible terms and low rates (the overnight rate on government securities collateral is normally below the overnight fed funds rate).

Conversely, repos also are used extensively for investment purposes. "Reversing in" securities offers institutions a means of investing variable amounts of money on a day-to-day or flexible term basis at favorable rates. Its term adjustability makes the repo a useful financial management tool for institutions investing temporary cash balances. (2)

Many large dealers engage in "matched-book" trading in repos, simultaneously entering into repo and reverse repo positions as a form of arbitrage on rates. The dealer attempts to borrow funds at one rate and lend them again at a higher rate to earn a spread. Other dealers also may use repos in arbitrage strategies.

A large portion of U.S. repo activity is cleared, netted, risk managed, and settled by the Government Securities Division of the Fixed Income Clearing Corporation. (3) FICC compares, nets, guarantees, facilitates settlement of, and manages the risk arising from all of the eligible transactions submitted to it by its members. (4) The clearance and settlement process provided by FICC is integral to the functioning of the U.S. government securities marketplace.

In November 1995, FICC (then known as the Government Securities Clearing Corporation) began providing netting and settlement services for repos. (5) Thereafter, FICC (6) began to implement a new repo product that would eliminate the need for dealers to devote collateral notification and allocation resources to each general collateral repo that they entered into. (7)

In November 1998, FICC revolutionized the financing marketplace by introducing a new trading product known as General Collateral Financing Repo, or GCF Repo, for Treasury securities collateral. After a slow start during its first two years, the GCF Repo service began growing significantly in volume in 2000 when Agencies and certain mortgage-backed securities (MBS) were made eligible products. ("Agencies" refers to unsecured corporate debt issued by such quasi-governmental entities as Fannie Mae, Ginnie Mae, Freddie Mac, and World Bank.)

On average, the FICC compared 415 GCF Repo transactions worth $184 billion each day during 20028 and had on its books total GCF term trades equal to $589 billion. The GCF Repo service offers a viable alternative for Wall Street dealers by promoting the expansion of the general collateral repo market, has become a valuable alternative to the tri-party repo market, and represents an important new vehicle for dealers to buy or sell collateral and finance positions.

Overview

The GCF Repo service enables FICC's non-inter-dealer-broker netting members (dealers) to trade general collateral repos (9)--based on rate, term, and underlying product--throughout the day without requiring intra day, trade-for-trade settlement on a delivery-versus-payment (DVP) basis. …