Why Is So Much Repo Not Centrally Cleared?

Views and opinions expressed are those of the authors and do not necessarily represent official positions or policy of the OFR or Treasury.

Unique Features of the Repo Market Segment Drive Transaction Volumes

Differences in haircuts, margining, and netting are primary factors that drive dealers to use the non-centrally cleared bilateral repurchase agreements (NCCBR) over other segments of the repurchase agreement (repo) market. In the new OFR brief “Why Is So Much Repo Not Centrally Cleared?” the authors use data from the OFR’s pilot data collection to document basic facts about volumes, rates, counterparty types, collateral, and haircuts in this relatively opaque segment of the repo market. This blog post explains one key finding from the brief.

The repo market is an integral component of the U.S. financial system, providing trillions of dollars of funding every day and facilitating trading in U.S. Treasuries and other securities. The repo market allows participants to borrow cash against securities pledged as collateral, with an obligation to repurchase those securities in the future. The largest of the four U.S. repo market segments, with an estimated market size exceeding $2 trillion outstanding, is the NCCBR segment. Unique features of NCCBR, particularly in terms of margining and netting, make it attractive form of repo.

More Than 70% of Treasury Repo in NCCBR Is Transacted with Zero Haircut

The NCCBR segment allows for greater flexibility in contract terms such as haircuts and margining. Haircuts are an important determinant of the attractiveness of a repo transaction because they pin down how much leverage can be taken on an individual trade.

Haircuts in NCCBR materially differ from those in tri-party repo. For Treasury repo in NCCBR, 74% of all volume is transacted at zero haircut—a material departure from non-centrally cleared tri-party repo, where the median haircut on Treasury collateral has held consistently at 2% for over a decade.

Netted Packages Play a Large Role in Driving Zero Haircuts

The prevalence of zero-haircut Treasury repo is due in part to the use of netted packages. In a netted package, a customer will approach a dealer for a repo trade with one piece of Treasury collateral that is matched with a reverse-repo trade against another piece of collateral. In effect, these trades allow the customer to temporarily swap one Treasury for another. Netted packages are particularly popular in non-centrally cleared repo since they reduce balance sheet costs: dealers can net down their gross exposure for regulatory purposes whenever a repo and a reverse-repo trade have the same end date and counterparty, even if they are over different pieces of collateral. At the same time, netted trades may be considered to have lower risk since counterparty exposure is significantly reduced.

The authors estimate that 70% of hedge fund repo borrowing and 57% of hedge fund repo lending at zero haircuts are netted, suggesting that among these trades, netted packages play a large role in driving zero haircuts. However, 30% of zero-haircut repo with hedge funds and 43% of zero-haircut reverse repo with hedge funds are not netted according to their estimates. The reasons for these zero haircuts on non-netted trades merit more examination, and it may be important to obtain more data on margining practices within large dealers.

Flexibility of Terms and Margining Make the NCCBR Segment Advantageous

One difference between the centrally cleared repo segments and the NCCBR segment is how margining is handled. The flexibility of terms and margining make the NCCBR segment advantageous, especially for trades such as netted packages, which would receive no additional netting benefit from being novated to FICC.

For transactions that are centrally cleared, margins are calculated on the portfolio level using a proprietary value-at-risk framework developed by FICC. For NCCBR transactions, as for non-centrally cleared tri-party repo transactions, haircuts on each individual transaction determine margins collected for that transaction (though other margin may be collected from that counterparty by the dealer across positions outside of repo).

Beyond haircuts and netting, secondary drivers of NCCBR volumes include the greater variety of collateral and maturities available in this segment. FICC-cleared repo only allows for Fedwire-eligible securities to be used as repo collateral, so participants seeking to transact specific-collateral repo on non-Fedwire securities must use NCCBR to facilitate these trades. Additionally, the majority of FICC-cleared bilateral repo trades are overnight, so participants seeking longer-tenor trades may also have to transact in a non-centrally cleared venue.

The OFR’s pilot collection provided a unique window into the non-centrally cleared bilateral repo market segment. In January, the OFR proposed a permanent collection of data from this segment of the market. This data would allow regulators to evaluate the expansion of this activity going forward and provide transparency into potential financial-stability risks building up in this key funding market.

iSee Margins data from Federal Reserve Bank of New York. Tri-Party/GCF Repo. 2023. Federal Reserve Bank of New York. https://www.newyorkfed.org/data-and-statistics/data-visualization/tri-party-repo/.
iiFor more details on repo netting rules, see Financial Accounting Standards Board. “Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements.” Interpretation, Norwalk, CT: FASB Interpretation No. 41 (December 15, 1994). https://www.fasb.org/page/PageContent?pageId=/reference-library/superseded-standards/summary-of-interpretation-no-41.html&bcpath=tff/.
iiiNon-centrally cleared tri-party repo, or tri-party for short, does allow the use of non-Fedwire collateral; however, tri-party only allows for general-collateral repo, not special-collateral repo. Thus, market participants seeking specific-security repo for non-Fedwire collateral are left with NCCBR as the only viable venue in which to transact trades.