from the New York Fed
— this post authored by Viktoria Baklanova, Cecilia Caglio, Marco Cipriani, and Adam Copeland
Repurchase agreements (repos) are financial contracts in which one party sells a security to the other with the promise to repurchase it at a later date for a pre-specified price. Securities dealers use repos to borrow funds on a collateralized basis, to provide funding to others, and to borrow or lend specific securities using cash as collateral. Repo markets are an important component of the U.S. financial system. They are a key source of funding for securities dealers and their clients, and a provider of secondary market liquidity for a variety of U.S. securities, such as U.S. Treasuries and agency mortgage-backed securities. They also play an important role in the pricing and price discovery of cash and derivatives instruments.
However, repo contracts may also give rise to systemic risk in financial markets in the form of fire sales (e.g., see Begalle et al (2013)).
In the United States, the repo market can be separated into two segments based on differences in settlement. In triparty repos, clearing and settlement occurs through a settlement system operated by a clearing bank, a process that provides collateral valuation, margining and management services and ensures that the terms of the repo contract are met. In contrast, for bilateral repo, the lender is responsible for the valuation and margining of the collateral pledged by the borrower.
Before the 2007-09 financial crisis, regulators and policymakers in the United States had only limited access to data on repo activity, which impeded their ability to identify emerging risks in these markets and make well-informed policy decisions. Since then, in line with the Financial Stability Board recommendation for a timely and comprehensive collection of repo data, steady progress has been made on data collection for repo activity that settles on the clearing banks’ triparty repo platforms. Until now, however, U.S. regulators and policymakers have not collected detailed data on bilateral repo activity. As emphasized in Baklanova, Copeland, and McCaughrin (2015), addressing this data gap is important because bilateral trades constitute a major segment of the U.S. repo market.
In 2014, the Office of Financial Research and the Federal Reserve System, with input from the Securities and Exchange Commission, launched a voluntary pilot data collection focused on the bilateral repo market. Nine bank holding companies (BHCs) participated in the pilot on a voluntary basis, reporting trades executed by all of their U.S. BHC-affiliated securities dealers. Although the pilot initially focused on collecting data on bilateral repo trades, we broadened the pilot on advice from participating dealers to include economically equivalent trades documented under securities lending agreements. Indeed, the economic effect of a repo contract can also be accomplished using a securities lending contract in which a security is lent (for a fee) using cash as collateral. The participating dealers reported that counterparties sometimes prefer to use a securities lending contract when negotiating an exchange of cash for collateral, perhaps reflecting differences in prevailing market practice or regulatory requirements. By collecting data on repos and securities lending trades against cash, we aim to get a more complete picture of the bilateral repo market.
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Source: https://www.newyorkfed.org/ medialibrary/ media/research/ staff_reports/ sr758.pdf?la=en
