Academic journal article Federal Reserve Bank of New York Economic Policy Review

An Empirical Analysis of the GCF Repo[R] Service

Academic journal article Federal Reserve Bank of New York Economic Policy Review

An Empirical Analysis of the GCF Repo[R] Service

Article excerpt

1. INTRODUCTION

General Collateral Finance Repo (GCF Repo[R]) is a financial service that allows securities dealers to exchange government securities for cash among themselves on an anonymous basis. (1) GCF Repo plays an important role in the tri-party repo market, a market that is essential to the funding of large broker-dealers in the United States. But because of a paucity of available data, knowledge about participants' GCF Repo trading strategies is mostly anecdotal. Market participants report that GCF Repo can play several roles: For some dealers, GCF Repo is a main source of their repo funding. For other dealers, GCF Repo can be used to perform collateral swap trades, allowing them to acquire Treasury securities, the highest quality collateral, in exchange for agency mortgage-backed securities (MBS), which are of lesser quality. GCP Repo is also said to serve as a "buffer" for some dealers, making it possible for them to obtain more funding or more collateral, if they are affected by an unexpected shock. Using newly available data on the universe of GCF Repo activity, we aim to quantify the behavior of dealers that enter into GCF Repo contracts to see if that behavior is consistent with the anecdotal evidence.

Understanding the role of GCF Repo, and its interactions with the tri-party repo market, is important as the repo market evolves. The tri-party repo market has been affected by the reforms of its settlement process (see the first article in this volume, "The Financial Plumbing of the GCF Repo Service"), which are likely to shape the costs of settling GCF Repo transactions. In addition, Basel III reforms, and in particular the supplementary leverage ratio, are having an effect on the costs of repo activity for broker-dealers. By examining dealers' behavior before the reforms were implemented, we provide a benchmark that can used to understand how reforms might influence GCF Repo activity over time.

In this article, we provide three sets of results on the strategies dealers pursue when entering into GCF Repo contracts. First, we describe daily activity by looking at end-of-day settlement and documenting which groups of dealers use GCF Repo for funding. We find considerable variety among dealers, but, on average, those dealers that are not part of a bank holding company (BHC) consistently borrow cash (against securities) in this market. For some of these dealers, GCF Repo appears to be a main source of repo financing.

Second, we examine activity in the GCF Repo market using two different measures of dealers' net and gross activities.

We infer that, on average, 1) 23 percent of dealers use GCF Repos to raise funds, 2) 20 percent of dealers use GCF Repo to source collateral or conduct collateral swaps, and 3) the remaining 57 percent of dealers follow a variety of strategies when entering into GCF Repos, including acting as liquidity providers to other participants. We also look at whether dealers engage in collateral transformation--for example, swapping agency MBS for U.S. Treasury securities. Although this type of activity has been increasingly talked about in recent years, we find only modest evidence of collateral swaps in the GCF Repo market.

Third, we examine whether dealers' strategies for entering into GCF Repo and tri-party repo contracts are related.

We find a negative correlation between daily changes in the amount of cash a dealer raises using tri-party repo and daily changes in the amount raised using GCF Repo. This correlation suggests that dealers view these two financial services as substitutes at the margin. In other words, GCF Repo appears to play the role of a "buffer" when a dealer experiences an unexpected shock.

2. GENERAL DESCRIPTION

We begin by providing a general overview of the GCF Repo service, followed by a description of our data.

2.1 Institutional Details

The Fixed Income Clearing Corporation (FICC) introduced the GCF Repo service in 1998. …

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