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Understanding Repurchase Agreements

by Mark Stockley, Managing Director and Head of International Cash Sales, BlackRock

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

In this article, we look to explain the fundamentals of this important sector and provide insight into its usage and operation.

What is a repurchase agreement?

In its simplest form, a repurchase agreement is a collateralised 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 essence, this makes a repurchase agreement much like a short-term interest-bearing loan against specific collateral. Both 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 utilised by money market funds. Repurchase agreements are typically done on an overnight basis, while a small percentage of deals are set to mature longer and are referred to as ‘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 lender.

As mentioned, the most widely used form of repurchase agreements by money market funds is referred to as the tri-party repo market which recently stood at approximately $1.7tr1. These agreements use a third party — a custodian bank or clearing organisation known as the ‘collateral agent’ — to act as an intermediary between the counterparties to a deal. The role of the collateral agent is critical: it acts on behalf of both the borrower and lender minimising 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 dealer’s assets.

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