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

A Primer on the Gcf Repo® Service: Introduction

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

A Primer on the Gcf Repo® Service: Introduction

Article excerpt

1. Background

Repurchase agreements, or repos, are widely used by financial entities to access money markets. Primary dealers, for example, reported financing $1.9 trillion of securities using repo on July 31, 2013.1 This primer, which consists of this introduction and two articles, focuses on a particular type of repo, the General Collateral Finance Repo (GCF Repo®). The Fixed Income Clearing Corporation (FICC) introduced this financial service in 19982 as a cost-effective way for securities dealers to exchange securities and cash (Fleming and Garbade 2003).

The two articles in this primer concentrate on different aspects of the GCF Repo service. The first article, "The Financial Plumbing of the GCF Repo Service," focuses on how GCF Repo trades are cleared and settled and describes how GCF Repo is affected by the current reforms to the settlement of repos. In particular, the authors lay out the various ways that intraday credit was used pre-reform to facilitate the settlement of GCF Repo trades and why this use of credit was problematic. They then describe the reforms that have been, or are scheduled to be, implemented and the effect of these reforms on the use of intraday credit.

The second article, "An Empirical Analysis of the GCF Repo Service," focuses on how dealers use this financial service. After describing the various strategies that dealers may employ, the authors quantify the predominance of these strategies. For example, they describe the types of dealers seeking funding through GCF Repo and the amount of cash typically borrowed. They also explain how dealers use GCF Repo in conjunction with their other repo transactions, in normal times and during periods of stress.

Although the two articles focus on different aspects of GCF Repo, they are complementary, because the strategies that dealers may follow in trading GCF Repos are influenced by the clearance and settlement procedures in place. Furthermore, in order to gauge the risks of potential changes to the clearance and settlement of GCF Repo, it is important to take into account how GCF Repos are traded.

Both articles rely upon a basic understanding of GCF Repo, so we provide an overview of the topic in this introduction (see also Ingber [2003]). We begin by broadly describing repurchase agreements and then focus on the institutional details of GCF Repo. We end by summarizing the main benefits of GCF Repo.

2. Repurchase Agreements

Repos are essentially a pair of separate but related transactions between two entities: an agreement to buy a security now (which constitutes the opening leg of the repo), joined with an agreement to sell back the same security in the future at a specified price (the closing leg).3 Apart from their treatment under bankruptcy, repos often resemble collateralized loans, with the difference in the price of the security across the two legs of the repo transaction translating into an interest rate. In addition to their use in sourcing funds, repos are also used to invest temporary cash balances, for arbitrage purposes, and as a tool for implementing a variety of other strategies. Adopting the view of a repo as a collateralized loan, we designate the entity purchasing (and then reselling) the securities as the cash investor. The other entity is labeled the collateral provider.

Two important elements of the repo agreement are negotiating which securities can be posted as collateral and negotiating the total value of securities to be posted as collateral. When repos are used for funding, which is the more usual case, industry practice is for the value of collateral to exceed the amount of cash.4 This difference is called the margin, and it measures the amount by which a repo is overcollateralized. The margin protects the cash investor in the event that the collateral provider defaults on its repurchase agreement, by providing a buffer against fluctuations in the value of the securities posted as collateral or a loss in value associated with the quick liquidation of securities. …

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