REPO Structure and terminology
Answer Posted / shinoj.k.s.
A repo is economically similar to a secured loan, with the
buyer (effectively the lender or investor) receiving
securities as collateral to protect against default of the
seller (effectively the borrower). Almost any security may
be employed in a repo, though practically speaking highly
liquid securities are preferred because they are more
easily disposed of in the event of a default and, more
importantly, they can be easily secured in the open market
where the buyer has created a short position in the repo
security through a reverse repo and market sale; by the
same token, illiquid securities are discouraged. Treasury
or Government bills, corporate and Treasury/Government
bonds, and stocks may all be used as "collateral" in a repo
transaction. Unlike a secured loan, however, legal title to
the securities clearly passes from the seller to the buyer.
Coupons (installment payments that are payable to the owner
of the securities) which are paid while the repo buyer owns
the securities are, in fact, usually passed directly onto
the repo seller. This might seem counterintuitive, as the
ownership of the collateral technically rests with the
buyer during the repo agreement. It is possible to instead
pass on the coupon by altering the cash paid at the end of
the agreement, though this is more typical of Sell/Buy
Backs.
Although the underlying nature of the transaction is that
of a loan, the terminology differs from that used when
talking of loans because the seller does actually
repurchase the legal ownership of the securities from the
buyer at the end of the agreement. So, although the actual
effect of the whole transaction is identical to a cash
loan, in using the "repurchase" terminology, the emphasis
is placed upon the current legal ownership of the
collateral securities by the respective parties.
The following table summarizes the terminology:
Repo Reverse repo
Participant Borrower
Seller
Cash receiver Lender
Buyer
Cash provider
Near leg Sells securities Buys securities
Far leg Buys securities Sells securities
Types of repo and related products
There are three types of repo maturities: overnight, term,
and open repo. Overnight refers to a one-day maturity
transaction. Term refers to a repo with a specified end
date. Open simply has no end date. Although repos are
typically short-term, it is not unusual to see repos with a
maturity as long as two years.
Repo transactions occur in three forms: specified delivery,
Tri-party, and held in custody. The third form is quite
rare in developing markets primarily due to risks. The
first form requires the delivery of a prespecified bond at
the onset, and at maturity of the contractual period. Tri-
party essentially is a basket form of transaction, and
allows for a wider range of instruments in the basket or
pool. Tri-party utilizes a tri-party clearing agent or bank
and is a more efficient form of repo transaction.
Due bill/hold in-custody repo
In a due bill repo, the collateral pledged by the (cash)
borrower is not actually delivered to the cash lender.
Rather, it is placed in an internal account ("held in
custody") by the borrower, for the lender, throughout the
duration of the trade. This has become less common as the
repo market has grown, particularly owing to the creation
of centralized counterparties. Due to the high risk to the
cash lender, these are generally only transacted with
large, financially stable institutions.
Tri-party repo
The distinguishing feature of a tri-party repo is that a
custodian bank or international clearing organization, the
tri-party agent, acts as an intermediary between the two
parties to the repo. The tri-party agent is responsible for
the administration of the transaction including collateral
allocation, marking to market, and substitution of
collateral. Tri-party agents administer US$ trillions of
collateral. They therefore have the scale to subscribe to
multiple data feeds to maximise the universe of coverage.
As part of a tri-party agreement the three parties to the
agreement, the tri-party agent, the repo buyer and the repo
seller agree to a collateral management service agreement
which includes an "eligible collateral profile". It is
this "eligible collateral profile" that enables the repo
buyer to define their risk appetite in respect of the
collateral that they are prepared to hold against their
cash. For example a more risk averse repo buyer may wish to
only hold non-financial, primary market, equity as
collateral. In the event of a liquidation event of the repo
seller the collateral is highly liquid thus enabling the
repo buyer to sell the collateral quickly. A less risk
averse repo buyer may be prepared to take non investment
grade bonds as collateral, these may be less liquid and may
suffer a higher price volatility in the event of a repo
seller default, making it more difficult for the repo buyer
to sell the collateral and recover their cash. The tri-
party agents are able to offer sophisticated collateral
eligibility filters which allow the repo buyer to create
these "eligibile collateral profiles" which can
systemically generate collateral pools which reflect the
buyer's risk appetite.[clarification needed] Collateral
eligibility criteria could include asset type, issuer,
currency, domicile, credit rating, maturity, index, issue
size, average daily traded volume, etc. Both the lender
(repo buyer) and borrower (repo seller) of cash enter into
these transactions to avoid the administrative burden of bi-
lateral repos. In addition, because the collateral is being
held by an agent, counterparty risk is reduced. A tri-party
repo may be seen as the outgrowth of the due bill repo, in
which the collateral is held by a neutral third party.
Whole loan repo
A whole loan repo is a form of repo where the transaction
is collateralized by a loan or other form of obligation
(e.g. mortgage receivables) rather than a security.
Equity repo
The underlying security for most repo transactions is in
the form of government or corporate bonds. Equity repos are
simply repos on equity securities such as common (or
ordinary) shares. Some complications can arise because of
greater complexity in the tax rules for dividends as
opposed to coupons.
Sell/buy backs and buy/sell backs
A sell/buy back is the spot sale and a forward repurchase
of a security. It is two distinct outright cash market
trades, one for forward settlement. The forward price is
set relative to the spot price to yield a market rate of
return. The basic motivation of sell/buy backs is generally
the same as for a classic repo, i.e. attempting to benefit
from the lower financing rates generally available for
collateralized as opposed to non-secured borrowing. The
economics of the transaction are also similar with the
interest on the cash borrowed through the sell/buy back
being implicit in the difference between the sale price and
the purchase price.
There are a number of differences between the two
structures. A repo is technically a single transaction
whereas a sell/buy back is a pair of transactions (a sell
and a buy). A sell/buy back does not require any special
legal documentation while a repo generally requires a
master agreement to be in place between the buyer and
seller (typically the SIFMA/ICMA commissioned Global Master
Repo Agreement (GMRA)). For this reason there is an
associated increase in risk compared to repo. Should the
counterparty default, the lack of agreement may lessen
legal standing in retrieving collateral. Any coupon payment
on the underlying security during the life of the sell/buy
back will generally be passed back to the seller of the
security by adjusting the cash paid at the termination of
the sell/buy back. In a repo, the coupon will be passed on
immediately to the seller of the security.
A buy/sell back is the equivalent of a "reverse repo".
Securities lending
The general motivation for repos is the borrowing or
lending of cash. In securities lending, the purpose is to
temporarily obtain the security for other purposes, such as
covering short positions or for use in complex financial
structures. Securities are generally lent out for a fee.
Securities lending trades are governed by different types
of legal agreements than repos.
Reverse Repo
A reverse repo is simply the same repurchase agreement from
the buyer's viewpoint, not the seller's. Hence, the seller
executing the transaction would describe it as a "repo",
while the buyer in the same transaction would describe it
a "reverse repo". So "repo" and "reverse repo" are exactly
the same kind of transaction, just described from opposite
viewpoints. The term "reverse repo and sale" is commonly
used to describe the creation of a short position in a debt
instrument where the buyer in the repo transaction
immediately sells the security provided by the seller on
the open market. On the settlement date of the repo, the
buyer acquires the relevant security on the open market and
delivers it to the seller. In such a short transaction the
seller is wagering that the relevant security will decline
in value between the date of the repo and the settlement
date.
Reverse Repo Rate
3.50% (w.e.f. (19/03/2010) Increased from 3.25%, which was
continuing since 21/04/2009.
Uses For the buyer, a repo is an opportunity to invest cash
for a customized period of time (other investments
typically limit tenures). It is short-term and safer as a
secured investment since the investor receives collateral.
Market liquidity for repos is good, and rates are
competitive for investors. Money Funds are large buyers of
Repurchase Agreements.
For traders in trading firms, repos are used to finance
long positions, obtain access to cheaper funding costs of
other speculative investments, and cover short positions in
securities.
In addition to using repo as a funding vehicle, repo
traders "make markets". These traders have been
traditionally known as "matched-book repo traders". The
concept of a matched-book trade follows closely to that of
a broker who takes both sides of an active trade,
essentially having no market risk, only credit risk.
Elementary matched-book traders engage in both the repo and
a reverse repo within a short period of time, capturing the
profits from the bid/ask spread between the reverse repo
and repo rates. Presently, matched-book repo traders employ
other profit strategies, such as non-matched maturities,
collateral swaps, and liquidity management
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