A repurchase agreement (repo) is an agreement to sell securities (referred to as “collateral”) at a given price, coupled with an agreement to repurchase these securities at a pre-specified price at a later date (Repo market functioning, Committee on the Global Financial System, Bank for International Settlements, CGFS Papers No 59, April 2017, p. 4, 5).
Specific repo’s legal definition is laid down in Article 3(9) of the Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse (SFTR), where it is described as a transaction governed by an agreement by which a counterparty transfers securities, commodities, or guaranteed rights relating to title to securities or commodities where that guarantee is issued by a recognised exchange which holds the rights to the securities or commodities and the agreement does not allow a counterparty to transfer or pledge a particular security or commodity to more than one counterparty at a time, subject to a commitment to repurchase them, or substituted securities or commodities of the same description at a specified price on a future date specified, or to be specified, by the transferor, being a repurchase agreement for the counterparty selling the securities or commodities and a reverse repurchase agreement for the counterparty buying them.
Report on securities financing transactions and leverage in the EU Report prepared under the mandate in Article 29(3) SFTR, 4 October 2016, ESMA/2016/1415, p. 43 - 45
Measured either by turnover or notional outstanding, repos are the main type of SFTs used in the EU.
Quarterly turnover in the secured segment (i.e. repos) of EUR money markets amounted to almost EUR 30tn over the last five years.
However, this figure excludes the sizeable UK gilt repo market for which no turnover data are available.
In terms of notional values, a frequently-cited industry survey puts the gross notional amount of repos at EUR 5.6tn as of December 2015.
The Bank of England publishes notional outstanding data on the UK gilt market. The gross amount of repos outstanding is around GBP 500bn, in line with the findings of the industry survey mentioned above.
One noteworthy trend is the downward trend in repo volumes reported by banks, while European repo markets were largely interbank, in contrast with the growing volumes reported for other types of market participants.
According to the industry survey, which includes both Euro area and other EU countries, around 90% of repo transactions are collateralised with fixed income securities, with the very large majority issued by sovereign, quasi-sovereign or supranational entities.
More than half of the pool of fixed-income collateral originated from Germany, UK, France and Italy.
Repos can be traded bilaterally, with or without CCPs, or through tri-party agents which take care of post-trading services, including the allocation of collateral across clients.
While the bilateral repo market is essentially interdealer, tri-party repos take place between dealers and customers.
In the tri-party repo market segment (around 10% of EU markets), usually used for financing purposes, the pool of collateral tends to be more diversified with sovereign debt accounting for around half of the total, compared with a combined share of 35% for transactions using corporate bonds, equities, covered bonds or securitised assets as collateral.
The quality of the collateral is high nonetheless, with AAA and AA- rated securities making up for more than 50% of the total.
There is no mandatory central-clearing of SFTs in the EU.
However, voluntary clearing of certain types of SFTs is possible and takes place to varying degrees.
In repo markets, the incentive of lighter capital requirements for banks has led to a growing share of centrally cleared repos, although estimates vary significantly between data sources.
This is the case in particular for the so-called General Collateral market (GC) which is used for financing purposes.
According to ECB turnover data, the share of centrally cleared repos in the Euro Area is around two thirds, significantly higher than five years ago.
This compares with around 30% of repos outstanding, according to industry survey data.
The volume of secured EUR funding transactions occurring on Eurex Repo's GC Pooling market, the Pan-European marketplace for financing trades in the EUR secured money market, has steadily decreased since 2014.
Contrasting evidence from ICAP shows that trading volumes for centrally cleared repo EUR repo markets have only slightly declined since 2014, suggesting that the decline in GC financing has been offset by a comparable increase in the volume of "specials".
LCH.Clearnet Group reported EUR 147tn and Eurex AG 89tn in repo clearing volumes in 2015.
Repos are typically very short-term instruments. According to ECB data, more than 75% of repo turnover has a one-day maturity or less.
This compares with only 16% for outstanding repo amounts, based on industry survey data.
The decline in GC Pooling volumes was mainly due to a decrease of around 60% in the volume of tomorrow-next and spot-next transactions, while trades volumes for longer maturities remained comparably stable.
In summary, the main trends in repo markets are:
- Predominant use of (high-quality) government bonds as collateral;
- A decline in the volume of GC financing transactions;
- A large but decreasing volume of very short-term transactions;
- A growing share of centrally-cleared repo turnover, at least in the Euro Area;
- A stable share of tri-party repos, usually using highly-rated securities;
- The growing relevance of non-banking repo counterparties, at least in the UK.
The definition of the repurchase transaction is also included in Article 4(1)(83) of the Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms (CRR).
According to this provision repurchase transaction means ‘any transaction governed by a repurchase agreement or a reverse repurchase agreement’.
Article 4(1)(84) of the CRR also contains the definition of the ‘simple repurchase agreement’, it means ‘a repurchase transaction of a single asset, or of similar, non-complex assets, as opposed to a basket of assets’.
Repos belong to the broader categories of:
- Securities financing transactions (SFTs) in the SFTR meaning, as well as
A reverse repo is the same set of transactions seen from the perspective of the party lending cash and receiving the securities as collateral (Repo market functioning, op.cit., p. 4).
“A reverse repo, by definition, is the opposite of a repo, i.e. buying assets first, then selling them back at a later date” (Final Report, Technical standards under SFTR and certain amendments to EMIR, 31 March 2017, ESMA70-708036281-82, p. 353).
Functions of repo transactions
As the aforementioned BIS and CGFS Paper No 59 (p. 4, 5) observes, “repo is economically similar to a collateralised loan since the securities provide credit protection in the event that the seller (i.e. the cash borrower) is unable to complete the second leg of the transaction. Collateral haircuts and regular margin payments further protect the lender against fluctuations in the value of the collateral. Repo transactions offer considerable flexibility to counterparties. For instance, the party receiving the collateral can reuse it (e.g. it can sell the securities outright, obtain cash through another repo, use them for margin calls). In addition, repo transaction settlements usually entail shorter delays than those for outright purchases of the same securities. Finally, in most jurisdictions, repurchase transactions are subject to favourable treatment under the insolvency law because they are exempted from automatic stay under bankruptcy. This means that, in the event of a default by the cash borrower, counterparties have access to the securities and the right to liquidate them.”
According to the ESMA's Final Report of 31 March 2017 Technical standards under SFTR and certain amendments to EMIR (ESMA70-708036281-82), repos are used in particular:
- as a source of funding - repos offer a cheap way of obtaining funding, repo rates tend to be lower than unsecured loans rates of borrowing due to lower credit and liquidity risks (if the collateral provider defaults, the collateral taker can sell the collateral to recover its loss, collateral takers can also re-use the collateral),
- for hedging - the use of repo to fund long positions and cover short positions in underlying assets is fundamental to hedging and the pricing of derivatives,
- for liquidity and collateral management - the ability to trade using repos provides liquidity in the market for securities, more trading facilitates price discovery which can further improve liquidity.
Specific business case for using repos is Article 45(2) of the CCP RTS (Regulation 153/2013), which envisions that a CCP must invest 95% of cash assets that it receives in non-cash assets - this is typically done typically through reverse repurchase agreements (FIA Response of 18 July 2017 to the European Commission EMIR Review Proposal – Part 1 (REFIT Proposals)).
Repo plays a significant role in the EURO money market.
ESMA's Final Report of 31 March 2017 (Technical standards under SFTR and certain amendments to EMIR, ESMA70-708036281-82) estimates the quarterly turnover on repos around €30 trillion in 2015 for Euro Area banks (and the total value of repo contracts outstanding, for the 72 institutions, at the level of €5.4 trillion in June 2016).
The aforementioned ESMA Report of 31 March 2017 observes the steady increase since the financial crisis of the proportion of repos cleared through CCPs - from 40 per cent of the secured EURO money market in 2009 to around 75 per cent in 2015.
There are three main EU repo market segments: bilateral repos, bilateral repos cleared through CCPs and tri-party repos.
The main collateral providers in repos are broker-dealers, investment banks and leveraged investors such as hedge funds.
They sell securities to the cash-rich, and often very risk-averse investors such as, money market mutual funds and international institutions.
Central banks are also important players in the repo market, although they are out of scope of SFTR.
Since the financial crisis, non-financials such as sovereign wealth funds, pension funds, insurance companies, endowments and corporate treasuries have also joined the repo market.
Banks and broker-dealers act both as borrowers and lenders in the market. They use techniques such as matched-book trading to net off assets so that they do not appear on the balance-sheet, which reduces capital requirements and lowers the cost of capital.
BIS and CGFS Paper No 59 observed the repo markets bring together two types of end users that interact through intermediaries:
- the first type includes those that provide collateral in return for cash (e.g. asset managers, pension funds, hedge funds and insurance companies), and
- the second type of end users is those investing in cash while receiving collateral (e.g. money market funds or corporate treasurers).
Collateral and cash can pass through one or more intermediaries in order to fulfil the needs of cash lenders (borrowers of collateral) and cash borrowers (providers of collateral).
When it comes to intermediaries’ types, the aforementioned CGFS’ document confirms that repos are almost exclusively intermediated by leveraged institutions (typically large banks and broker-dealers) that stand between end users (such repo intermediation activity sometimes referred to as “matched book” repo, as securities borrowed by the dealer are matched by those lent).
In some jurisdictions, cash providers use the “triparty” repo market, where contracts settle on the books of a clearing agent.
Banks and broker-dealers are also significant end users of repos in their own right, for financing their market-making inventory, sourcing short-term funding or investing cash.
However, the maturities of SFTs rarely match perfectly.
Banks may need to finance long-term illiquid assets through short-term liquid assets, which often results in maturity transformation. This is often the case for big insurance companies. According to the aforementioned ESMA Report of 31 March 2017, such a strategy was one of the reasons that caused AIG to run into liquidity stress during the financial crisis.
Government bonds were the main type of collateral within the pool of EU-originated fixed-income collateral, accounting for 86 per cent in June 2016.
In terms of the currencies of the cash involved, the majority (61.3per cent) is euros. This is followed by US dollars (17.1 per cent) and UK pound sterling (11.6 per cent).
82.5 per cent of the total value of securities loaned or borrowed are on fixed rate, 10.8 per cent are on floating rate, and the remaining are on open rate.
Repos are mostly short-term in nature.
Around 75 per cent of transactions have one-day maturities and less than 3 per cent have maturities longer than a month.
In value terms, more than 50 per cent of repos have a term of less than a month, with 23.5 per cent having a one-day term.
Repos with maturities of more than a year account for only 1.7 per cent of the total market.
Overall, since 2011, there seems to have been an upward trend in the value of repo with a remaining term to maturity of one day and a downward trend in the value of repo with maturity of more than one year.
This reflects the increasingly short-term nature of the repos on demand.
There could be more than two parties involved in a repo transaction.
For instance, in a tri-party repo, instead of being delivered to the lender, the collateral is held in a custodian bank or a clearing house.
The latter is the tri-party agent responsible for post-trade processing and collateral selection (e.g. quality, liquidity) based on the criteria pre-set by the buyer.
In Europe, the principal tri-party agents are Clearstream Luxembourg, Euroclear, Bank of New York Mellon, JP Morgan and SIS.
They are usually responsible for managing non-government bonds and equity (ICMA (2016) “What is tri-party repo?”).
As the tri-party agents do not participate in the trade, the associated risks still lie solely with the counterparties.
Tri-party repos accounted for only 10 per cent of the overall EU repo market.
For tri-party repos, government-related assets account for 56 per cent of the total collateral for tri-party agents.
Repurchase transactions are subject to reporting requirements as laid down in Article 4(1) of the SFTR and in the secondary legislation.
For the purposes of repurchase transactions' reporting, with respect to counterparties roles ESMA proposes to use the terms "collateral giver" and "collateral taker".
In the case of repo trades, the counterparty that buys securities, commodities, or guaranteed rights relating to title to securities or commodities on the opening or spot leg of the trade and agreeing to sell them at a specified price on a future date (closing or forward leg of the trade) is to be identified as the collateral taker.
The other counterparty shall be identified as the collateral giver.
As ESMA argues, the counterparty would always know whether it provides or receives the collateral.
Moreover, given that in the case of repos, a counterparty is both a buyer and a seller at different points in the transaction ESMA confirmed that the counterparty role (collateral taker and collateral giver) is to be determined based on the opening leg of the repo or buy-sell back as previously specified (Consultation Paper Draft RTS and ITS under SFTR and amendments to related EMIR RTS, 30 September 2016, ESMA/2016/1409, p. 44, 45).
Three repo reporting scenarios depicted in the aforementioned ESMA's Report of 30 September 2016 (p. 45 - 53) are described below.
1. Repo trade without central clearing is the simplest form of a repo trade. It involves two counterparties, for i.e. the lender of the security, commodity, or guaranteed right and the cash giver. The counterparties may choose to use the services of a broker/agent to initiate the trade with the counterparty. The broker/agent does not become a counterparty to the repurchase transaction when the broker/agent only acts on behalf of the counterparty and does not take the position in its own books.
In turn, in a repo trade with central clearing, a CCP interposes between the two counterparties to the trade and becomes a counterparty to a trade. Therefore, the CCP is subject to the SFTR reporting obligation. In the case of establishment of interoperability arrangements between CCPs, transactions between the two CCPs are also reportable.
In the ESMA's assessment the principal clearing model is currently the most common client clearing model in Europe for repos (Consultation Paper of 30 September 2016, p. 49).
2. Another repo reporting scenario occurs when a CCP is interposing itself between the two counterparties that are not clearing members.
This results in the creation of a distinct legal contract between the clearing member and its client (a 'back-to-back contract) in addition to the legal contract between the CCP and the clearing member.
Four new trades result from the clearing of the original trade in the principal model, i.e. between each counterparty and its respective clearing member and mirror transactions between each clearing member and the CCP.
In this case, all five actors (counterparties 1 and 2, clearing members 1 and 2, and the CCP) are subject to the SFTR reporting obligation, resulting in eight reports to the trade repositories (ESMA 's Consultation Paper of 30 September 2016, p. 50).
3. The third scenario of reporting of centrally cleared repos reflects the agency clearing model.
ESMA observes, currently, this model is not used in Europe but may exist in other jurisdictions.
It falls within the scope of SFTR reporting where SFTs are entered into by EU counterparties but cleared in foreign CCPs, where such models may exist.
In this repo reporting scenario a CCP is interposing between the two counterparties that are not clearing members and the clearing members participate in agent capacity, hence two new trades result between each original counterparty and the CCP.
Consequently, there will be four reports in total (two for the trade between the Counterparty 1 and the CCP and two for the trade between the CCP and Counterparty 2).
In this scenario, clearing members act as agents and do not become counterparties subject to the SFTR reporting obligation.
This scenario also covers both following cases: the "sponsored access to CCP" where asset managers (Counterparty 1 or 2) are "sponsored by a clearing member" and the "direct clearing for buy side customers" where there could be another clearer (different from the clearing member) that acts as a clearing agent for the buy side customer (Counterparty 1 or 2).
A broker or a tri-party agent could also be involved in the central clearing scenarios, and, if so, should be reported as above.
Final Report, Technical standards under SFTR and certain amendments to EMIR, 31 March 2017, ESMA70-708036281-82, p. 353
Repo refers to repurchase agreements, where the collateral provider sells an asset or bundle of assets to the collateral taker at price X with an agreement to buy back the equivalent assets at a later date, or on demand in the case of open repo, at price Y. The difference between price Y and price X is usually annualised to a percentage called the repo rate.
Effectively, the repo rate is the collateral taker’s rate of return for lending money to the collateral provider. There are different types of repos depending on the contractual agreements and the parties involved, and the process may involve a broker helping the counterparties to initiate the trade. A reverse repo, by definition, is the opposite of a repo, i.e. buying assets first, then selling them back at a later date.
The assets associated with repos are typically bonds and other fixed-income securities, though other types of securities can be used. Repos with equities are called “equity repo” and those using mortgage loans are called “whole loan repo”. Repos can also be classified based on the characteristics of the underlying assets. General Collateral (GC) repos use liquid securities that are considered homogeneous and used indiscriminately by the market participants, where the choice of collateral asset is made only after the trade.
Special repo, on the other hand, involves securities that have specific characteristics which are in high-demand at a given moment, and in this case the choice of security is known before the trade is executed. As a result, special repos tend to be security-driven, whereas GC deals tend to be cash-driven.
ESMA's Report of 30 September 2016 proposes, moreover, to include the market value of the securities as a required element of transaction data for repo and reverse repo trades.
According to the said recommendation the reporting counterparties would update this information on a daily basis.
The market value should be at close of business of each business day as it is used for collateral management purpose, i.e. the market value used to calculate daily variation margin.
Reporting entities should use the "Other modification" action type.
Where repo transaction has been reported under the SFTR, it is excluded from the definition of the "transaction" for the purposes of the MiFID II reporting under Article 26 of MiFIR (Article 2(5)(a) of the Commission Delegated Regulation (EU) 2017/590 of 28 July 2016 supplementing Regulation (EU) No 600/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the reporting of transactions to competent authorities).
ESMA's Guidelines on Transaction reporting, order record keeping and clock synchronisation under MiFID II of 10 October 2016 (ESMA/2016/1452) refer specifically to repos in the practical example of two investment firms which enter into a repurchase agreement in relation to a sovereign bond, where one of the investment firms reports the transaction under the SFTR.
ESMA's Guidelines confirm that in this case there is no MiFID II transaction reporting obligation for either of the investment firms since this repo transaction has been reported under the SFTR.
The same applies where an investment firm is acting for a collective investment undertaking under a discretionary mandate and enters into a repurchase agreement in relation to a sovereign bond. Assuming that the fund has reporting obligations under SFTR and the investment firm does not, there is no transaction reporting obligation in such case for the investment firm under MiFIR since the transaction has been reported under the SFTR.
Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012 (SFTR), Article 3(9)
Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (CRR), Article 4(1)(83), Article 4(1)(84)