Understanding repurchase agreements

The repurchase agreement (repo) market is one of the largest and most actively traded sectors in the short-term credit markets and is an important source of liquidity for money market funds (MMFs). Below, we highlight key points about repo securities, the repo market and how its used within the Cash industry.

For a deeper understanding of repo, please read our Cash Academy paper entitled Understanding repo: A cash building block.

What is a repurchase agreement?

A repurchase agreement is a contractual arrangement between two parties, where one party agrees to sell securities to another party at a specified price with a commitment to buy the securities back at a later date for another (usually higher) specified price.

Repos that mature next day or at a specified date in the future are called "overnight repo" and "term repo," respectively. Repo with no specified maturity date are considered "open" and can be terminated by either party at any time.

How do cash investors use repo?

Repurchase agreements are used by certain MMFs to invest surplus funds on a short-term basis and by financial institutions to both manage their liquidity and finance their inventories.

Cash investors may utilize term repo to fulfill a specific need for a customized period of time.

How are repo rates determined?

The two most important factors that impact repo rates, in our opinion, are:

    • terms of the agreement including tenor and price of the collateral
    • types of securities subject to the repurchase agreement

There are two types of securities used in repo agreements:

    • Traditional: U.S. Government securities including U.S. Treasuries, agency debt, and agency mortgage-backed securities (MBS)
    • Non-traditional: Non-government securities including corporate investment grade and non-investment grade debt as well as equity securities

Repo rates for each transaction are negotiated based on several other factors including market conditions, supply and demand for certain forms of collateral, and the credit quality of the underlying securities.

What is tri-party and cleared repo?

 

Tri-party repo uses a "tri-party" agent (usually a custodian bank or clearing organization) to serve as an intermediary between the buyer and seller. The collateral agent minimizes the operational burden in the transaction, prices the securities under the transaction, and holds the collateral separate from the dealer's assets, layering in protection to the buyer in the event the dealer goes bankrupt.

Image depicting tri-party repo transaction process

Source: BlackRock. For illustrative purposes only

Cleared repo is a specific form of tri-party repo in which an approved member of the Fixed Income Clearing Corporation (FICC) sponsors a non-dealer counterparty to transact on the FICC's cleared repo platform. This platform settles trades through the Delivery Versus Payment settlement process, a method which permits the transfer of securities only after payment is made.

How does the Federal Reserve use repo?

The Federal Reserve (Fed) plays a key role in the repo market.  By engaging in open market operations, the Fed is able to regulate the money supply and bank reserves, helping keep the federal funds rate within the target range, as set forth by the Federal Open Market Committee.

When the Fed purchases repo, it is infusing cash into the market; on the other hand, when the Fed does the inverse ("reverse repo"), it is removing liquidity from the market.

How does BlackRock use repo?

BlackRock deploys an outsized allocation of assets to repurchase agreements in efforts to strengthen the liquidity characteristics of the funds, as well as to generate total returns on excess cash balances.

Each repurchase agreement transaction is thoroughly vetted through our robust three-tiered credit review. Any potential repo transaction under consideration for a portfolio would initially be vetted through our robust three tiered credit review process to determine any associated risks, including a careful analysis of each and every counterparty with whom we engage to help ensure that the portfolios meet the high credit standards of BlackRock.

To learn how repurchase agreements could benefit your portfolio, please contact your relationship manager.

This material is intended for information purposes only, and does not constitute investment advice,a recommendation or an offer or solicitation to purchase or sell any securities to any person in any jurisdiction in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The opinions expressed are as of November 2020 and are subject to change without notice. Reliance upon information in this material is at the sole discretion of the reader. Investing involves risk.

 

In the U.S. this material is intended for public distribution.

 

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