Overview of Repo

September 2010 Jean-Michel MEYER Managing Director - Global Head of Repo

By March 2008, however, the financial turmoil reached a point where heightened risk aversion coupled with uncertainty over valuations of particularly risky products led participants in the repo market to abruptly stop accepting anything other than Treasury and agency collateral. As a result, investment banks such as Bear Stearns suddenly found themselves short of funding, as a large part of their collateral pool was no longer accepted by the US repo market.
BIS Quarterly Review, December 2008 Developments in repo markets during the financial turmoil By Peter Hrdahl and Michael R King

Repo : a definition

Repo is an agreement to sell securities and to buy them back at an agreed future date and price which includes the return on the use of the sale proceeds during the term of the repo, expressed as an interest rate.

Reverse Repo or Repo Underlying: Govies, EM, Corporate bonds Nominal x start price -> start cash Haircut / Initial margin

Rate: fixed, floating ( Libor, Fed Funds, Eonia) Maturity: fixed, open Recall notice: none, 24 h, 48 h Right of substitutions
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Different types of Secured Financing

Bond Borrow Security Lending Funded TRS Cross Currency Repos Triparty Repos Buy and Sell Back Repo GMSLA, OSLA, MSLA GMSLA, OSLA ISDA GMRA GMRA (RSA) Undocumented, or GMRA GMRA, MRA

Specials GC Repo: General Collateral Driven by the need for a specific security Driven by the need for cash Is a Cost for the bond borrower ( fixed rate lower) No requirement for a specific security Linked to the cash Outright market But accept a pre-agreed range of bonds (basket) Alternative to unsecured money

The different players

The cash lenders: repo is a better alternative to unsecured lending ( money market) Money market funds / Mutual funds Treasury desks from banks, corporates, Insurance companies Central Banks (Reserve managers) Repo desks

The Bond lenders: repo as a funding tool Dealers, Bond traders Hedge Funds Proprietary trading desks Repo desks

Electronic Trading Platforms Central counterparty Clearing houses (CCPs) : DTC, LCH.Clearnet, EUREX Central Banks for their official money market operations
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The main driving forces

Reduced credit risk Collateral in exchange for cash Daily margining Double indemnity

COUNTERPARTY CREDIT RISK HIGH LOW

CREDIT ASSESMENT OF THE ISSUER

HIGH

LOW

Lower capital requirement Deep and Liquid market

Main trading interactions in the bank

Bond Traders

Treasury Department

REPO DESK

Investment Books ALM

Sales

CLIENTS BANKS

Central Banks - Monetary Policy operations

BROKERS

Servicing internal desks Servicing external Clients

Implementing Trading strategies

Outright positioning Relative Value Specials trading

Management of a repo trade

Corporate actions ( coupon payments ) Substitutions Haircut/ Initial margin Daily margining
T

REPO Trade UST 1 7/8 30/06/2015 Nominal: $ 97 mios Cash price: 102.75 Accrued: 0.315 Start cash $ 100 mios

$ 100 mios

Lend Borrow

CASH BONDS
$ 100 mios

The key requirements

Due Dilligence Know Your Customer Legal Capacity Netting enforceability Eligibility Criteria for the underlying assets Liquidity in the outright cash markets Pricing availability Wrong Way Risk - Correlation Concentration risk Adapt collateral to the risk profile of the counterparty Investment People IT systems Governance/ processes

Accounting & Regulatory Capital

Balance Sheet (BS) Reverse Repo appears on the Buyers BS as a loan ( advance to banks/customers) The collateral stays on the sellers BS he keeps the risk and the related economic profit Repo appears on the liability side of the sellers BS ( cash loan received)

Netting Generally no netting Big Balance Sheet impact Under some accounting regimes, netting is allowed if trades are done through Central Clearing Counterparty Houses (CCPs) and same End Date

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Managing a Default under GMRA

The trade is accelerated The main risk parameters ( volatility, liquidity, correlation) will evolve to the worse. A default notice is sent Transaction is closed and collateral is sold The other secured cash lenders will want to sell assets at the same time: procyclicality in the market A dynamic management is required, including additional trigger events Increased haircuts, rates or early terminate a trade if the credit stance ( Rating, CDS) of the collateral or the counterparty gets weaker
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The European Repo market in numbers ( source ICMA)

Total Value of Repo outstanding ( bn)
7,000 6,000 5,000 4,000 3,000 2,000 1,000 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Jun-09 Dec-09

63% with maturities shorter than 1 month 27% done through Automatic Trading Systems 8% is Triparty 29% done through CCPs

60% of collateral is Government bonds 89% is done with a fixed rate 61% of the business is done by the Top10 Banks

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Conclusion and Trends

Repo has attracted a lot of attention A big shift from unsecured into secured A bigger focus on quality and liquidity of accepted collateral A more dynamic management of haircuts/other mitigants in relation to Wrong Way risk A more robust legal framework

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QUESTIONS AND ANSWERS

Contact Details: jean-michel.meyer@hsbc.com

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