Fed Reporting of overnight and continuing repurchase agreements represented in Trillions of Dollars

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

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. Securities dealers use these deals to manage their liquidity and finance their inventories. While repurchase agreements are commonly found within money market funds as short term, mostly overnight investments, the cash investor might look to invest cash for a more customized period of time to fulfill a specific investment need. As these transactions are short termand considered relatively safe due to the secured collateral, market liquidity and rates remain competitive for all investors.

The recent financial crisis highlighted the significant role repurchase agreements have come to play in the short term liquidity markets. In 2008 at the high water-mark for the sector, an estimated $2.8 trillion of securities (source: Federal Reserve Bank of NY — May 2010), were funded through repurchase agreements. Major investment banks such as Bear Stearns and Lehman Brothers relied heavily on these deals to fund their operations. As their financial difficulties became more apparent, other institutions reduced their credit lines, including repurchase agreements, or declined to lend to them altogether. As a result, they ran into financial difficulties, and regulators and investors alike became acutely aware of the extent to which these transactions were employed by investment banks’ dealers to fund their operations. Regulators concluded that banks’ over-reliance on repurchase agreements for short term funding was a major contributing factor toward instability in the financial markets. As a result, domestic and international regulation in both the banking and securities markets has been amended in recent years, to reduce the potential for repurchase agreements to “freeze” the credit markets.

While this market remains a highly significant sector for lenders and borrowers alike, the overall size has been reduced from its 2008 peak to its current position of around $1.7 trillion (source: Federal Reserve Bank of NY — October 2011). Recent industry reforms, such as changes to custodial bank intra-day credit, settlement processes and a widespread reduction in banks’ leverage have strengthened the sector and it remains important for money market funds and other institutional investors, in particular as a source of overnight liquidity.

Source: BlackRock on Repurchase Agreements: getDocument

 

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