Repurchase agreements (repos) are extensively used in dealer financing, customer funding, and matched book trading. The repo desk has become the hub around which revolve the trading, hedging, and arbitrage strategies. At many firms the repo desk has become a key profit center. In addition, understanding the market is essential to assessing value in the securities markets. For example, the status of a bond in the repo market can be used to understand the relative values between bonds and also to assess the valuation of futures contracts. This chapter first describes the structure, development, trading mechanics, and market practices. Subsequent sections cover the upper and lower bounds of special repo rates, and the brokering and matched book transactions. It is important for bankers to understand the clearing process, fail consequences, the PSA-recommended trading guidelines, and GSCC netting services as well. Finally, the chapter also examines key issues related to the emerging equity repos.
The repo market is the biggest money market, with the estimated market at $17.5 trillion and turnover at perhaps $500 billion a day.1 This is much larger than the Fed funds and is the biggest short-term money market in the world. In July 1996, the Fed adopted changes to Regulation T by loosening its provisions on valuing certain securities pledged as collateral from the previous 50% to discretionary “good faith.” The relaxation of Regulation T will further benefit the development of the fixed-income repo market and will, together with the National Securities Markets Improvement Act of 1996, help give birth to the equity repo market.
In a typical repo transaction, a dealer puts up liquid securities as collateral against a cash loan while agreeing to repurchase the securities at a future date. The start-leg, or leg one, is usually settled the same day. The close-leg, or leg two, repurchase is a forward transaction. A repo is, in format, a securities transaction, but is, in essence, a collateralized loan to finance the purchase of the underlying security. The repo markets are therefore often called financing markets.