A conclusion of the US Securities and Exchange Commission’s (SEC) final rules on mandatory clearing is that Guaranteed Repo is exempted. This important distinction means that the financial benefits of Guaranteed Repo are available to all market participants both now and after the mandate goes live in 2026.
The rule requires repo transactions in which at least one of the “counterparties” is a “direct participant” in FICC (i.e. an FICC netting member) to be cleared. Transactions among “indirect participants” (sponsored members) and non-members of FICC are not subject to the clearing requirement. This outcome holds true even if the performance of one or both principals (“counterparties”) are guaranteed by a direct participant. Guarantors in these “Guaranteed Repo” transactions are not counterparties/principals to trades; they are contingent obligors.
The majority of repo market end users of cash and collateral (e.g. hedge funds) and end providers (e.g. money market funds) are either sponsored members or non-members of FICC. Therefore, Guaranteed Repo transactions among these counterparties are not subject to the clearing requirement.
While Guaranteed Repo is exempt from the clearing rule, it is important to note that it was not developed in reaction to the rule, but instead was constructed and marketed long before the rule’s origin. In fact, Guaranteed Repo’s primary and longstanding goal has been to enhance market efficiency and reduce risk by reducing cost, operational risk, credit risk and systemic risk. It complements the regulatory goals that served as the impetus behind mandatory clearing.
What is Guaranteed Repo?
Guaranteed Repo allows banks to perform their vital credit intermediary role in repo markets without using their balance sheets. Banks facilitate repo trades among counterparties that do not normally trade directly with one another (e.g. hedge funds and money market funds) by guaranteeing the performance of the low-credit quality counterparty. Because banks are not counterparties to these transactions in the guarantee model, they do not hit banks’ balance sheets.
Guaranteed Repo is a highly efficient solution to address the demands of changing regulations
The regulatory landscape is changing significantly, and the changes are likely to profoundly impact secured funding markets. In addition to the increased costs resulting from the SEC’s clearing rule, Basel III Endgame rules are likely to increase banks’ RWAs/capital for exposures to low-rated and unrated counterparties, further increasing costs that will impact returns and volumes for all repo market participants. The efficiency of Guaranteed Repo can mitigate the impact of these regulatory changes and facilitate the smooth functioning of the repo market and related cash trading markets.
Guaranteed Repo transactions result in lower gross and net balance sheet usage, RWAs, costs and operational requirements than all other secured funding trading models, including uncleared on-balance sheet “matched book” repo trades, cleared repo trades, total return swaps, securities lending transactions and margin loans. RWAs can be 40%-100% lower than other secured funding trading models while costs will likely be 6+ bps lower than matched book trading (these efficiencies do not include the significant benefits of bilaterally negotiated haircuts rather than haircuts prescribed by clearinghouses). Guaranteed Repo transactions are also not subject to minimum haircuts for transactions collateralized with non-defaulted government bonds.
Guaranteed Repo Is electronic, has global scalability and its implementation Is easy and straightforward
Guaranteed Repo, developed pursuant to a joint initiative of Sunthay, Bloomberg and Euroclear, incorporates several features that greatly reduce the lift required to adopt and scale. The structure integrates standardized documentation (developed by Sunthay), electronic trading (supported by Bloomberg), and fully integrated post-trade collateral management services (delivered by Euroclear) whilst maintaining existing custody arrangements in place.
Guaranteed Repo is a global solution. It conforms to Basel III regulatory requirements, international accounting standards (US GAAP and IFRS), and incorporates standardized documentation based on standard form MRAs and GMRAs. It also utilizes uniform electronic trading protocols and integrated post-trade collateral management processes.
Because Guaranteed Repo utilizes existing repo trading conventions, documentation and operational procedures, it requires minimal resources to implement. This ease of implementation coupled with scalability makes it a highly attractive alternative and complement to clearing for most market participants. Guaranteed Repo is therefore a valuable solution for dealing with the impact of regulation, particularly for banks that are facing substantially higher capital and operational costs associated with clearing.
What next?
The final clearing rule will likely fundamentally change the structure of secured funding markets. The current default structure for repo trading – the “matched book” model – is likely to be limited to the trade types that are explicitly excluded in the rule. But what will take its place? Obviously, clearing will become more widespread but it is not the only alternative. Guaranteed Repo is likely to become widely implemented, particularly for transactions that are marginally profitable or unprofitable when cleared.
A window in which to adopt Guaranteed Repo
The timeframe for adoption of the clearing rule offers repo market participants a crucial window to implement Guaranteed Repo. Until FICC finalizes its rule book (no later than March 2025), market participants will not have full knowledge of the scope of the build they must undertake. This window gives market participants time to analyze and implement Guaranteed Repo. The concept of guarantees is well understood, and Bloomberg and Euroclear possess the expertise and experience to scale the structure globally.
Market participants will benefit from adopting Guaranteed Repo as an alternative or complement to clearing or other solutions to address the coming upheaval in repo markets.
Firms seeking to learn more about Guaranteed Repo are encouraged to reach out to Shiv Rao at shiv.rao@sunthay.com.
This article was sponsored by Sunthay.