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Repurchase agreement
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== Types == {{More citations needed|section|date=July 2021}} Repo transactions occur in three forms: specified delivery, tri-party, and held in custody (wherein the "selling" party holds the security during the term of the repo). The third form (hold-in-custody) is quite rare, particularly in developing markets, primarily due to the risk that the seller will become insolvent prior to maturation of the repo and the buyer will be unable to recover the securities that were posted as collateral to secure the transaction. The first form—specified delivery—requires the delivery of a prespecified bond at the onset, and at maturity of the contractual period. Tri-party is essentially a basket form of transaction and allows for a wider range of instruments in the basket or pool. In a tri-party repo transaction, a third party clearing agent or bank is interposed between the "seller" and the "buyer". The third party maintains control of the securities that are the subject of the agreement and processes the payments from the "seller" to the "buyer." === Due bill/hold in-custody repo / bilateral repo === In a '''due bill repo''', the collateral pledged by the (cash) borrower is not actually delivered to the cash lender. Rather, it is placed in an internal account ("held in custody") by the borrower, for the lender, throughout the duration of the trade. This has become less common as the repo market has grown, particularly owing to the creation of centralized counterparties. Due to the high risk to the cash lender, these are generally only transacted with large, financially stable institutions. === Tri-party repo === The distinguishing feature of a '''tri-party repo''' is that a [[custodian bank]] or [[Clearing house (finance)|international clearing organization]], the tri-party agent, acts as an intermediary between the two parties to the repo. The tri-party agent is responsible for the administration of the transaction, including collateral allocation, [[Mark-to-market|marking to market]], and substitution of collateral. In the US, the two principal tri-party agents are [[The Bank of New York Mellon]] and [[JP Morgan Chase]], whilst in Europe the principal tri-party agents are [[Euroclear Bank]] and [[Clearstream Banking SA]] with SIX offering services in the Swiss market. The size of the US tri-party repo market peaked in 2008 before the worst effects of the [[2008 financial crisis]] at approximately $2.8 trillion and by mid-2010 was about $1.6 trillion.<ref name = "Gillian">{{Cite web | url= http://www.ft.com/cms/s/0/692d4184-c72d-11df-aeb1-00144feab49a.html |archive-url=https://ghostarchive.org/archive/20221210/http://www.ft.com/cms/s/0/692d4184-c72d-11df-aeb1-00144feab49a.html |archive-date=10 December 2022 |url-access=subscription |url-status=live | title= Repo needs a backstop to avoid future crises | work= [[The Financial Times]] | author= [[Gillian Tett]] | date = 23 September 2010 | access-date=24 September 2010}} </ref> As tri-party agents administer the equivalent of hundreds of billions of USD of global collateral, they have the scale to subscribe to multiple data feeds to maximise the universe of coverage. As part of a tri-party agreement the three parties to the agreement, the tri-party agent, the repo buyer (the Collateral Taker/Cash Provider, "CAP") and the repo seller (Cash Borrower/Collateral Provider, "COP") agree to a collateral management service agreement which includes an "eligible collateral profile". It is this "eligible collateral profile" that enables the repo buyer to define their risk appetite in respect of the collateral that they are prepared to hold against their cash. For example, a more risk averse repo buyer may wish to only hold [[On the run (finance)|"on-the-run"]] government bonds as collateral. In the event of a liquidation event of the repo seller the collateral is highly liquid thus enabling the repo buyer to sell the collateral quickly. A less risk averse repo buyer may be prepared to take non investment grade bonds or equities as collateral, which may be less liquid and may suffer a higher price volatility in the event of a repo seller default, making it more difficult for the repo buyer to sell the collateral and recover their cash. The tri-party agents are able to offer sophisticated collateral eligibility filters which allow the repo buyer to create these "eligible collateral profiles" which can systemically generate collateral pools which reflect the buyer's risk appetite.<ref>In other words, if the lender seeks a high rate of return they can accept securities with a relatively high risk of falling in value and so enjoy a higher repo rate, whereas if they are risk averse they can select securities which are expected to rise or at least not fall in value.</ref> Collateral eligibility criteria could include asset type, issuer, currency, domicile, credit rating, maturity, index, issue size, average daily traded volume, etc. Both the lender (repo buyer) and borrower (repo seller) of cash enter into these transactions to avoid the administrative burden of bi-lateral repos. In addition, because the collateral is being held by an agent, [[counterparty]] risk is reduced. A tri-party repo may be seen as the outgrowth of the '''due bill repo''. A due bill repo is a repo in which the collateral is retained by the Cash borrower and not delivered to the cash provider. There is an increased element of risk when compared to the tri-party repo as collateral on a due bill repo is held within a client custody account at the Cash Borrower rather than a collateral account at a neutral third party. === Whole loan repo === A whole loan repo is a form of repo where the transaction is collateralized by a loan or other form of obligation (e.g., mortgage receivables) rather than a security. === Equity repo === The underlying security for many repo transactions is in the form of government or corporate bonds. Equity repos are simply repos on equity securities such as common (or ordinary) shares. Some complications can arise because of greater complexity in the tax rules for dividends as opposed to coupons. === Sell/buybacks and buy/sell backs === A sell/buyback is the spot sale and a forward repurchase of a security. It is two distinct outright cash market trades, one for forward settlement. The forward price is set relative to the spot price to yield a market rate of return. The basic motivation of sell/buybacks is generally the same as for a '''classic repo''' (i.e., attempting to benefit from the lower financing rates generally available for collateralized as opposed to non-secured borrowing). The economics of the transaction are also similar, with the interest on the cash borrowed through the sell/buyback being implicit in the difference between the sale price and the purchase price. There are a number of differences between the two structures. A repo is technically a single transaction whereas a sell/buyback is a pair of transactions (a sell and a buy). A sell/buyback does not require any special legal documentation while a repo generally requires a master agreement to be in place between the buyer and seller (typically the SIFMA/ICMA commissioned Global Master Repo Agreement (GMRA)). For this reason, there is an associated increase in risk compared to repo. Should the counterparty default, the lack of agreement may lessen legal standing in retrieving collateral. Any coupon payment on the underlying security during the life of the sell/buyback will generally be passed back to the '''buyer''' of the security by adjusting the cash paid at the termination of the sell/buyback. In a repo, the coupon will be passed on immediately to the seller of the security. A buy/sell back is the equivalent of a "reverse repo". === Securities lending === In [[securities lending]], the purpose is to temporarily obtain the security for other purposes, such as covering short positions or for use in complex financial structures. Securities are generally lent out for a fee and securities lending trades are governed by different types of legal agreements than repos. Repos have traditionally been used as a form of collateralized loan and have been treated as such for tax purposes. Modern Repo agreements, however, often allow the cash lender to sell the security provided as collateral and substitute an identical security at repurchase.<ref>{{Cite web |url=http://www.cov.com/files/Publication/60f595c5-6bb2-4a4e-8fe2-5378a84cd91a/Presentation/PublicationAttachment/c4755b62-a153-47bc-b341-84e08001da31/Are%20Repos%20Really%20Loans.pdf |title=Archived copy |access-date=30 December 2010 |archive-date=6 March 2016 |archive-url=https://web.archive.org/web/20160306171954/https://www.cov.com/files/Publication/60f595c5-6bb2-4a4e-8fe2-5378a84cd91a/Presentation/PublicationAttachment/c4755b62-a153-47bc-b341-84e08001da31/Are%20Repos%20Really%20Loans.pdf |url-status=dead }}</ref> === Reverse repo === A reverse repo is simply the same repurchase agreement from the buyer's viewpoint, not the seller's. Hence, the seller executing the transaction would describe it as a "repo", while the buyer in the same transaction would describe it a "reverse repo". So "repo" and "reverse repo" are exactly the same kind of transaction, just being described from opposite viewpoints. The term "reverse repo and sale" is commonly used to describe the creation of a short position in a debt instrument where the buyer in the repo transaction immediately sells the security provided by the seller on the open market. On the settlement date of the repo, the buyer acquires the relevant security on the open market and delivers it to the seller. In such a short transaction, the buyer is wagering that the relevant security will decline in value between the date of the repo and the settlement date.
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