top of page
Search

UNDERSTANDING THE REPURCHASE AGREEMENTS

Updated: Sep 18, 2023


The repurchase agreement market is one of the largest and most actively traded sectors in short-term credit markets and an important source of liquidity for money market funds and institutional investors. Repurchase agreements are short-term secured loans frequently obtained by dealers (borrowers) to fund their securities portfolio, and by institutional investors (lenders) such as money market funds and securities lending firms, as sources of collateralized investment.

What is a repurchased agreement?



A repurchased agreement is a collateralized loan, involving a contractual arrangement between two parties, whereby one agrees to sell a security at a specified price with a commitment to buy the security back at a later date for another specified price. In other words, it is much like a short-term interest bearing loan against specific collateral; both between the counterparties in a deal-parties, the borrower and lender, are able to meet their investment goals of secured funding and liquidity. There are three types of repurchase agreements used in the markets: deliverable, tri-party and held in custody. The latter is relatively rare, while tri-party agreements are most commonly utilized by money market funds.

Repurchase agreements are typically done on an overnight basis, while small percentage of deals are set to mature longer and are referred to ‘term repo’, additionally, some deals are referred to as ‘open’, and have no end maturity date, but allow the lender or borrower to mature the repo at any time. In a deliverable repurchase agreement, a direct exchange of cash and securities takes place between the borrower and the lender.



In a tri-party repo market, a third party either a custodian bank or a clearing organization known as collateral agent act as intermediary between the counterparties to a deal. The role of the collateral agent is critical: it acts on behalf of both the borrower and the lender minimizing the operational burden and receiving and delivering out securities and cash for the counterparties. The collateral agent also serves to protect investors in the event of a dealer’s bankruptcy, by ensuring the securities held as collateral are held separate from the dealers assets.

Uses of repurchase agreements:

Repurchase agreements are used by money market funds to invest surplus funds on a short-term basis and by dealers as a key source of secured funding. Security dealers use these deals to manage their liquidity and finance their inventories. There are two types of collaterals; traditional/or general collateral this comprises of government securities including treasuries, agencies and agency mortgage securities and non-traditional /corporate or alternative repurchase agreements which may include a range of non-government securities including corporate investment grade and non-investment grade debt and even equity securities as collateral.

Use of traditional collateral, coupled with a shorter term, will typically result in a lower yield whereas use of non-traditional collateral, together with a longer term, will generally result in higher yields.

In all, the importance of tri-party in a repurchase agreement as a basis of investment funds in the money market cannot be overemphasized.



67 views0 comments
bottom of page