A recent "Market Strategy" research piece from Barclays comments on the "Dealer repo activity." Strategist Joseph Abate writes, "Overall, dealer activity in the repo market has held fairly steady in the past year. But dealer activity in the bilateral market is declining. Outside financing trades, dealers appear to be reversing in about the same amount of collateral. Dealers are active participants in the tri-party and bilateral repo markets. They use the tri-party market mainly to finance themselves and the bilateral repo market for trading specific collateral. Cash borrowings in the bilateral repo market have been falling since last summer. Bilateral repo now accounts for less than 35% of all dealer repo outstanding. Meanwhile, dealer tri-party repo volumes are increasing. We estimate that money funds provide about 40% of the $1.5trn in tri-party repo. Dealers are reversing in roughly the same volume of collateral in the bilateral market -- very little collateral is reversed in via the tri-party market (that is, outside of GCF)."
He continues, "We believe that pending regulatory changes will likely shrink the size of the tri-party repo market. However, while some of these financing trades might migrate to the bilateral market, we suspect that dealers are more likely to shrink as their ability to maintain a $600bn repo market funding gap declines."
Abate writes, "Overall, dealer repo and reverses outstanding, as measured by weekly reports submitted to the Federal Reserve Bank of New York, has been fairly steady in the past year. In July, dealers had an average $2.7trn in outstanding repo and $2.0trn in reverses. However, these figures measure all dealer activity in the repo market -- they do not parse out what portion of the amount outstanding comes from the tri-party or bilateral repo markets. Such a distinction might only be of interest to the handful of purists interested enough in the settlement mechanics of collateral trades to bother looking. However, dealer activity in each of these markets is driven by very different purposes and involves different counterparties. Moreover, as we noted several weeks ago ... the Fed is particularly concerned by the existence of intra-day credit provided by the two clearing banks in the tri-party market."
He explains, "In a tri-party repo trade, the cash and collateral are exchanged between the borrower (of cash) and the lender on the balance sheet of the clearing bank. Because the tri-party bank takes care of settlement, collateral pricing, and facilitates collateral substitution, tri-party trades are operationally more efficient than bilateral transactions. In bilateral transaction, the borrower and lender exchange cash and collateral simultaneously -- without the assistance of a third-party. Because the bilateral transaction is less efficient, it typically trades at a less competitive rate than tri-party repo transactions. Bilateral trades tend to involve specific collateral, like specials in the Treasury repo market."
Abate adds, "The lack of direct data on the size and activity in the bilateral market means that we have to estimate its size by netting out from the total dealer volumes outstanding all GCF and triparty transactions. Our figures only include Treasury, agency, MBS, and corporate collateral -- although we suspect that, like the tri-party market, this collateral accounts for the bulk of bilateral repo trades. These data suggest that dealers borrow roughly $1trn in bilateral repo trades -- an amount that has declined since last summer. Moreover, as a proportion of the overall amount of dealer repo, bilateral trades have shrunk from 44% to 34.5%."
He says, "By contrast, activity in the tri-party market has increased -– with dealer volumes rising from $1.3trn in May 2010 to $1.5trn in July 2012. Tri-party financing trades now account for almost 70% of dealer repo (cash) borrowings. In the past 12 months, tri-party repo volumes have climbed 17%, driven by very sharp gains in dealer financing against Treasury and MBS collateral (up 28% and 26%, respectively). A lack of new agency supply has reduced dealer pledging of this collateral by 7% in the past year, while at the same time corporate collateral (investment and non-investment grade) is being termed out and financed outside the repo market. Indeed, since last July, the Federal Reserve reports that the total volume of pledged corporate collateral has fallen by nearly 50%. Outside of this collateral, the volume of structured finance paper (ABS, CMOs, for instance) has held steady as a share of overall triparty repo volumes. However, a recent Fitch report noted that the proportion of this paper funded by money market funds has increased sharply since 2009."
Abate adds, "Money funds traditionally do repo with dealers in the tri-party repo market. And, over the past year, their demand for repo has increased. The $100bn gain in the last 12 months has been driven by a number of factors, including a lack of government-guaranteed supply (as the agency debt market contracts), and Operation Twist sales that have caused a disproportionate back-up in repo rates (of more than 10bp since January). As a share of taxable money fund balances, repo has risen from 20% to 25%. At the same time, the volume of taxable money repo financing as a proportion of the total amount of dealer triparty repo outstanding has held steady around 40% in the past year. In effect, not only are money funds a significant source of dealer financing, but their importance has risen (albeit mildly in percentage terms) in the past year."
Finally, he says, "As we recently wrote, we are not sure what the "reformed" tri-party repo market will look like, although we suspect that the market will be smaller and less non-traditional repo will be funded in the market. A smaller tri-party market -- particularly given the increase in its participation in the past year -- may create some congestion for money funds looking for safe investments among sparse government supply. But, there could be some relief if bilateral repo (currently at $1trn in outstandings) picks up the slack. However, this requires that some traditional tri-party lenders such as money funds sacrifice some of the efficiency from the tri-party market for access to more collateral in the bilateral market."
