Tag Archive for Repo

Spike in bill rates rippling through money markets – Sober Look

Yields on treasury bills with near-term maturities have spiked to multi-year highs as the debt ceiling deadline approaches. While market participants are generally expecting to see a resolution (albeit a temporary one), some are not taking any chances.

USA Today (AP): — Fidelity Investments, the nation’s largest money market mutual fund manager, has sold all of its short-term U.S. government debt — the latest sign that investors are increasingly nervous about the possibility of a government default.

Source: US Treasury

Institutional investors have rolled a chunk of their holdings into cash during September but in the last week or so started pulling out of government money market funds – moving funds into bank deposits instead.

Source: ICI

Investors fear that their accounts will be frozen, as money fund managers who don’t receive timely payments on bills are unable to meet redemptions. Many money market funds also use repo (collateralized loans) with treasuries or agency MBS as collateral. These short-term loans usually yield slightly more than treasury bills, giving money markets a few extra basis points. But with bills under pressure and investors getting out, repo rates have suddenly risen as well.

Bloomberg: – “We’ve seen some rise in repo rates in sympathy with the broad move higher in money-market yields, most dramatically in the near-term Treasury bills, given concerns over the debt-ceiling,” said Andrew Hollenhorst, fixed-income strategist at Citigroup Inc. in New York. “October futures contracts have had a sharp yield rise, signaling expectations for significant moves higher ahead, consistent with the sharp spike we saw in 2011 before the August debt-limit deadline.”

Source: DTCC

Some continue to believe that a technical default by the US government would impact treasury securities only. But as we see from the repo example, that assumption is quite naive. An adjustment to bill rates is already rippling through a number of other money market instruments. If we don’t have a resolution on the debt ceiling soon, the shock will ripple across broader markets as well.


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Fed contemplates creating "overnight reverse repo facility" – Sober Look

This is a syndicated repost courtesy of Sober Look. To view original, click here. Reposted with permission. Follow the money. Find the profits!Liquidity is money. Regardless of where in the world that money originates, eventually it flows to and through Wall Street. So if you want to know the direction of the next big moves…

Triparty repo and the clearing bank risks – Sober Look

Avi Cohen had a good comment on the recent post about repo transactions (here), pointing out that triparty repo custodians face some intraday risks. It is indeed an important issue and should be discussed.

Repo markets have functioned well for decades. However this recent paper published by the NY Fed (below) outlined potential systemic risks in the tri-party markets that became apparent in 2008. The concerns are not with the repo market itself or the lenders/borrowers under the contract, but with the clearing banks that facilitate triparty repo transactions.

Both lenders and borrowers under the repo agreement often prefer for a third party to hold collateral and arrange settlement. This is similar to using an escrow account when two parties don’t fully trust each other. Not surprisingly triparty repo usage has been increasing since the financial crisis and particularly when dealing with Eurozone banks (see discussion).

The risks the NY Fed discusses in their paper are posed by the clearing banks such as BoNY and JPM who handle some $100bn+ in repo each on a daily basis. Specifically the issue is with the exposure these custodians have on an intraday basis when repo transactions are unwound.

Consider the following scenario. On a quiet Friday morning a lender under the repo agreement informs her borrower that she wishes to unwind the repo loan and asks the borrower to return the money. The custodian (clearing bank) is told that the repo trade is closed. The clearing bank then transfers the funds to the lender, expecting to get that cash from the borrower upon the end of day settlement. But when the clearing bank, in the process of returning collateral bonds to the borrower, tries to settle, the borrower fails to make payment and the securities go back to the custodian (via DTC).

Now the clearing bank, stuck with these bonds, is forced to start selling. But it is Friday late afternoon and there are few buyers out there willing to even look at the bonds. The custodian bank goes into the weekend still holding the securities. On Sunday the media picks up the news that this particular borrower has failed. By Monday morning markets are in disarray and other repo lenders to the troubled borrower are stepping out of their repo, all forcing the clearing bank to liquidate more collateral. At the same time the other large clearing bank is doing the same. Now lenders to unrelated institutions are also spooked by this event and decide to step out of their loans as well. A panic ensues. Clearing banks are forced to liquidate billions in collateral that is declining in value. All of a sudden one of the clearing banks fails to make payment and the situation rapidly spirals out of control as all triparty lenders try to get their money out at the same time. It’s a run on the repo clearing banks that forces credit markets globally to freeze.

This scenario, though quite remote, could be catastrophic. It was a serious enough concern for the clearing banks in 2008 that one very large custodian chose to liquidate collateral without waiting for the end of day settlement – which landed it in court later. But at the time it was the rational thing to do.

NY Fed: – Bear Stearns and Lehman Brothers, during the financial crisis of 2007-09 highlighted the fact that the two tri-party clearing banks are not only agents, but also the largest creditors in the tri-party repo market on each business day. This daytime exposure is associated with the unwind of repos, a process by which the clearing banks send cash back to investors and collateral back to dealers, regardless of whether a repo is expiring.

Between the time of the unwind and the time at which new trades are settled near the end of the business day, dealers must finance the securities that serve as repo collateral. During this transition period, the clearing banks provide financing to dealers, collateralized by the dealers’ securities. This provision of intraday credit creates multiple risks.

To deal with the risks posed by the clearing banks in 2008, the Fed set up its own “clearing bank” to make sure repo markets continue to function. It was called the Primary Dealer Credit Facility (PDCF). It’s obviously no longer used, but this intraday settlement gap continues to pose some risks to the financial system (discussed in the paper).

These risks however have diminished since the financial crisis. Collateral haircuts are now higher, particularly for the less liquid bonds. Lenders restrict bond size/concentration that can be in the collateral pool to make sure they are able to liquidate them. And the bulk of the collateral handled by clearing banks these days is comprised of treasuries and agency bonds.


NY Fed on Triparty Repo



Repo transactions and shadow banking – Sober Look

We continue to get questions about the repo markets and the structure of repo transactions. The attached paper from the Financial Stability Board provides a good overview of repo and securities lending markets (including rehypothecation practices).

A repo transaction structure is quite simple.  Here is an example:

A hedge fund buys a high yield bond for $10mm. It then uses this bond as collateral to borrow $7.5mm from a dealer. That means the hedge fund puts up $2.5mm net to control a $10mm bond (similar to buying a house with a 25% down-payment) . The dealer will value the bond on a daily basis and if the bond declines in value, the hedge fund will be asked to post additional cash collateral (similar to a futures market). Most such transactions are overnight and are rolled (re-borrowed) daily. The risk to the hedge fund is that one day the dealer refuses to roll the loan and the fund would need to come up with $7.5mm to repay the bank, potentially forcing it to sell the bond quickly (and possibly at a loss). In fact this is how both Bear Stearns and Lehman failed, as their counterparties refused to roll their repo loans. A more likely scenario however is that the dealer raises the initial margin from 25% to say 30% forcing the fund to put up an additional half a million.

To reduce these risks, some funds (and some leveraged ETFs and closed-end funds) negotiate a longer dated repo – usually under 90 days. This gives the fund more time to find alternate sources of funding or liquidate the bond gradually – should market conditions require it.

Below is a generic diagram of a repo transaction, including the so-called tri-party repo (discussed here).

Source: FSB

One issue that keeps coming up repeatedly (including in this FSB paper) is whether this multi-trillion dollar market represents a form of “shadow banking” (discussed in this article by Dan Freed). In and of itself the repo market is no more a “shadow bank” than say the mortgage market. What makes something potentially a “shadow” banking transaction is the lending institution involved. For example a money market fund lending via repo or in some other fashion is a “shadow bank” because money funds are not bank holding companies. The repo example discussed above however does not represent shadow banking since a hedge fund would typically be borrowing from a registered bank. It’s an important distinction.

Securities Lending and Repos