Asset Classes4 分钟阅读

What Is a Repurchase Agreement (Repo)

If you sell a bond while simultaneously promising to 'buy it back in a few days,' are you selling it or borrowing? This peculiar trade is exactly what a repo is—and the hidden heart of the financial market.

A repo is really a 'collateralized short-term loan'

A repurchase agreement (repo) is a trade in which you sell a bond with the condition attached that you will 'buy it back at a set price after a certain period.'

Though the wording is 'selling a bond,' in substance it is borrowing money using the bond as collateral. You hand over the bond and receive cash, and on the agreed day you buy it back with interest added, getting the bond returned.

For example, if A hands a government bond to B and receives $740, and then agrees to buy it back for $740.40 a few days later, A has essentially borrowed $740 using the government bond as collateral and paid $0.40 in interest.

So the easiest way to understand a repo is as a 'short-term loan with collateral (a bond).' Because there is collateral, it tends to be safer than an unsecured loan.

The repo an individual meets vs. the repo institutions use

Repos are used in two broad worlds.

Repo-type products for individuals: Securities firms sell these to customers using their holdings of government and public bonds or high-grade bonds as collateral, in the form of 'deposit for a few days to a few months and receive a contracted interest rate.' This is exactly the basis of the RP-type CMA we saw earlier. Because there is collateral, the risk of principal loss tends to be low, but it is not covered by depositor protection.

Interbank repos: This is a market where financial institutions such as banks and securities firms lend and borrow funds among themselves on a very short-term basis (mostly overnight). The scale is enormous, and it plays the role of the 'lubricant' that keeps the financial system running every day.

We barely see it, but if this institutional repo market stumbles, the entire financial system can shake.

Repo-type products for individuals tend to be relatively safe because they have collateral, but they are not covered by depositor protection. 'Low risk' and 'guaranteed by the state' are two different stories. (Source: Bank of Korea economic terms, Wikipedia — Repurchase agreement)

In 2019, the U.S. repo market convulsed

How important the repo market is becomes clear when an accident strikes.

In September 2019, U.S. short-term repo rates suddenly spiked. The overnight secured rate (SOFR) more than doubled from 2.43% on September 16 to 5.25% the next day, and intraday it momentarily surged as high as 10%.

The cause was a combination of several factors. A large volume of Treasury issuance, corporations' tax payment date, and a situation where bank reserves had shrunk to a multi-year low, leaving the market short of cash, all coincided.

In the end, rates stabilized only after the Federal Reserve Bank of New York urgently injected $75 billion of liquidity on September 17 and intervened throughout that week.

This event, in which a normally quiet market convulsed overnight, remains a representative case showing how sensitive and important the short-term funding market is.

This event was not a problem with individual repo products but a temporary seizure in the 'interbank very-short-term funding market.' The figures are based on Federal Reserve and Office of Financial Research (OFR) materials. (Source: Federal Reserve FEDS Notes, Wikipedia — September 2019 repo market)

Things to remember when looking at repos

Because of the impression that a repo is a 'safe short-term product with collateral,' it is often introduced as a reasonable option even for beginners.

Indeed, repo-type products for individuals backed by government and public bond collateral tend to be low risk. But there are a few things you clearly need to know.

First, they are not covered by depositor protection. Having collateral simply lowers the risk; unlike a bank deposit, they are not products where the state guarantees your principal.

Second, the quality of the collateral matters. Safety differs depending on which bonds are pledged as collateral.

Third, as in the 2019 case, if the entire market seizes up, even short-maturity products can be affected.

In short, a repo is a useful tool for putting short-term funds to work, but it is not 'risk-free,' and it is safer to use it after confirming what collateral and terms are involved.

常见问题

Q. Is the principal guaranteed on repo-type products?

The principal is not 'guaranteed.' Because a repo is backed by government and public bonds or high-grade bonds as collateral, the risk of principal loss tends to be low, but it is not covered by depositor protection, nor does the state guarantee the principal. Safety varies depending on the quality of the collateral and the condition of the issuer, so you should understand the distinction between 'low risk' and 'risk-free.'

Q. Does the 2019 U.S. repo crisis have anything to do with individual investors?

The event itself took place in the very-short-term funding market between banks and securities firms, and it was not an incident where individual repo products directly suffered losses. That said, this case shows how important and sensitive the 'unseen short-term funding market' is. When such a market seizes up, the entire financial system can shake, which can ultimately affect the prices of various assets.