Non-centrally Cleared Bilateral Repo
BY Samuel J. Hempel, R. Jay Kahn, Vy Nguyen, and Sharon Y. Ross
As a crucial source of funding and liquidity for the U.S. financial system, the U.S. repurchase agreement (repo) market provides short-term financing to banks, securities dealers, and other financial institutions to fund their liquidity provisions and leveraged investments.
For years, regulators have called for greater insight and transparency into the repo market. The non-centrally cleared bilateral segment – where repo transactions are conducted between two firms without the involvement of a central counterparty or custodian – has been a particular blind spot for regulators.
In a blog published today, the Office of Financial Research explains what is known about the non-centrally cleared bilateral market, as well as how the OFR is laying the groundwork to fill this critical data gap through a data collection.
Why is non-centrally cleared bilateral repo so popular?
One insight that emerged from our outreach was the driving forces behind volumes in non-centrally cleared bilateral repo. As the statistics above suggest, this segment of the market is primarily dealers engaging with customers, particularly levered funds like hedge funds. The closest comparable segment is therefore FICC’s Sponsored DVP Service, which also allows hedge funds to trade with dealers. Sponsored DVP has additional benefits because dealers can use clearing to net borrowing by hedge funds against lending by money market funds (MMFs). With this advantage, it may be surprising that dealers do so much of their business through non-centrally cleared repo. However, in our conversations with market participants they pointed to three advantages of non-centrally cleared bilateral repo:
- Market participants report that many institutions do not have access to sponsored repo, and that onboarding new sponsored members can be costly and time-consuming.
- Sponsored repo has until recently been limited to overnight Treasury collateral and non-MBS agency securities, so market participants point out that non-centrally cleared bilateral repo allows for a greater variety of trades.
- Trades by relative value hedge funds are often naturally netted, so novating them to FICC would not yield additional benefits. Meanwhile, market participants report that in non-centrally cleared bilateral repo, dealers can offer lower haircuts on these funding packages than would be imposed by FICC on sponsored trades.
The blog post can be found here.