A Primer on GCF Repos
Murray Pozmanter, DTCC managing director, Clearance and Settlement Product Management
What exactly are repurchase agreements? They are financial transactions that constitute a major source of short-term – often overnight – financing. They typically rely on U.S. government securities for collateral and involve the sale of a security and the subsequent repurchase of the same security or one similar to it. Hence the name “repurchase agreement.” In 2007, the average daily value of repos outstanding in the U.S. market was more than $6.6 billion.
When it was introduced in 1998, the General Collateral Finance Repurchase (GCF Repo®) agreement effectively revolutionized the repo market. Created by FICC’s predecessor company in conjunction with its two settling banks – The Bank of New York and JPMorgan Chase – it allows dealers that are netting members of FICC’s Government Securities Division to trade general collateral repos throughout the day without requiring the delivery of a security and a cash payment for every single transaction.
Instead, GCF Repos can be traded based on rate, term and underlying security – and the trades are all netted at the end of the day. This feature makes them easier and cheaper to use. By giving broker/dealers a convenient and more flexible way to finance smaller instruments or positions with other dealers, it also helped to tap a new liquidity source: the other dealers.
Why the shutdown?
The inter-bank market for these repos grew so fast that certain payment risk issues arose from the inter-bank funds settlements related to the service. In 2003, FICC shifted the service to intra-bank status. Until the fund-transfer issues could be resolved, market participants that cleared at one bank could no longer execute GCF Repo agreements with counterparties who cleared at the other principal clearing bank.
GCF repos don’t require delivery versus payment of the underlying securities. That’s one reason they’re such a flexible instrument. As a result, however, only cash moves between the banks to support the transactions. Although these payments are unsecured, the funds movement was not viewed as much of a problem until repo volumes, and therefore the value of the payments associated with them, began to climb.
Why the reopening?
Now, the inter-bank service is being resumed because FICC, working with the two banks, has come up with a new way for the banks to balance out the intra-day fund movements involving GCF Repo trans-actions. Instead of morning and evening fund transfers between the two banks, each day’s fund flow is now netted into a single inter-bank movement of money at the end of the day.
Meanwhile, dealers at whichever bank is a net borrower on any given day give FICC an interest in the securities and deposit accounts they maintain at that bank. FICC then passes an interest in the collateral along to the creditor bank, which was supposed to receive the funds. FICC has also increased the collateral it requires its broker/dealers to post each day in order to clear their transactions.
When the fund transfers between the two banks are netted at the end of the day, FICC releases the collateral holds against the dealers as that day’s transactions are settled. @