Treasury Notes

 Examining Changes in the Treasury Repo Market after the Financial Crisis

By: James Clark and Tom Katzenbach

This blog post is the fifth in a series on fixed income market dynamics by the Department of the Treasury to share our perspectives on the available data, discuss key structural and cyclical trends, and reiterate our policy priorities.  This post examines the Treasury repo market.
The Treasury repurchase (repo) market helps facilitate trading in the world’s deepest, most liquid government securities market.  Repos involve a party borrowing cash from another while posting Treasury securities as collateral and paying interest.  Borrowing in the repo market takes place most commonly overnight, although a repo’s term could be for any mutually agreed upon time, such as one week or one month. 
This post explores some of the ways in which the Treasury repo market, both in the tri-party and the bilateral segments, has changed over the past several years, including: (1) the volume of market activity, (2) the relative price of repo, and (3) direct repo trading without a dealer intermediary.  Although this market has undergone a variety of changes since the financial crisis, the Treasury repo market continues to function well.
Size of the Treasury Repo Market: During the early- to mid-2000s, Treasury repo activity—defined here as the aggregate volume of overnight and term trades outstanding—increased significantly.  Primary dealer financing statistics collected by the Federal Reserve Bank of New York (FRBNY) indicate that repo activity more than doubled between 2002 and early 2008.  During the financial crisis, however, these volumes began to decline and were down by roughly 40 percent by the middle of 2009.  The data suggests that activity has remained relatively stable in the years since the crisis.  This trend in Treasury repo market activity has largely mirrored cash market trading volumes, which is consistent with the role that repo performs in market intermediation by facilitating the ability of market participants to (1) finance purchases of new Treasury securities from the US government at auction before distributing those securities to end investors and (2) intermediate between buyers and sellers in the secondary cash market.
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Source: FRBNY and SIFMA (financing volumes include securities lending activity)
Tri-party and Bilateral Repo Markets: Repo trades are settled in two ways.  In tri-party repos (general collateral, or GC), a clearing bank provides clearing and settlement services including collateral valuation, margining, and management services to ensure the terms of the repo contract are met (see this OFR Working Paper). General Collateral Financing (GCF) Repo Service, another tri-party platform, was introduced in 1998 by the Fixed Income Clearing Corporation and settles tri-party through Bank of New York Mellon and J.P. Morgan Chase.  Last month, J.P. Morgan Chase announced changes to its repo settlement business line, which are to be incorporated over the next couple of years.  Treasury anticipates a smooth transition and minimal impact on the functioning of the repo market.  In bilateral repos, meanwhile, the lender is responsible for the valuation and margining of the collateral pledged by the borrower.  These two segments (tri-party and bilateral) broadly compose the Treasury repo market as a whole.
Size of Tri-party Treasury Repo Market:  Data collected by FRBNY from the two tri-party clearing banks indicate that tri-party repo activity is well within its historical range and on an upward trend.  In fact, the June 2016 monthly snapshot showed volumes at highs since data became available in May 2010. 
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Source: FRBNY
Money market mutual funds (MMFs), as cash lenders, are significant participants in the tri-party repo market and rely on this market as a source of safe short-term investments.  Since 2011, the SEC and the Office of Financial Research (OFR) have provided a window into the magnitude of these volumes through their data collection efforts, now publicly available through the OFR’s U.S. Money Market Fund Monitor.  These data indicate that the magnitude of MMF repo investments with private sector counterparties—in other words, investments that are exclusive of the Federal Reserve’s reverse repo facility—are currently comparable to the volumes witnessed in 2011-2012.  Moreover, recent months have shown an increase in money market fund repo activity, with April 2016 showing the highest volumes since data became available in January 2011. 
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Source: SEC and Treasury-OFR
Neither dataset provides an indication of market size pre-crisis, but both indicate that repo market volumes remain in-line with levels witnessed over the past five years.
Prices in the Tri-Party Treasury Repo Market: The price of Treasury repo is the interest rate that market participants pay to borrow cash against Treasury collateral.  Similar to the way in which Treasury repo activity appears to have been range-bound over the past several years, the spread between overnight Treasury GCF and the Federal Reserve’s policy rate (fed funds effective, or FFE) has remained fairly level as well.  If the rate paid on overnight Treasury GCF moved consistently higher relative to FFE, it could reflect potential stresses in the repo market.  During the crisis, there were occasional situations when the unsecured rate traded significantly higher than the secured rate.  Since the crisis, however, the spread between these two rates has generally been reasonably stable.
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Source: DTCC and FRBNY
Overnight Treasury GCF transactions have averaged approximately $110 billion over the past year, representing only a small sub-section of the broader Treasury repo market.  These transactions are, however, one of the few publicly available data sources on Treasury repo pricing—particularly over longer time horizons.
Size of the Bilateral Treasury Repo Market: Although the availability of data about Treasury repo activity has increased over recent years, it remains insufficient, particularly for bilateral repo trading. To address this issue, the Office of Financial Research and Federal Reserve, with input from the Securities and Exchange Commission, launched a voluntary bilateral repo data collection in 2014 that collected information from a number of significant market participants (see the description of the interagency bilateral repo pilot).
The pilot showed that transactions involving U.S. Treasuries represented the majority of collateral transacted in the bilateral repo market. The pilot participants reported $416.4 billion of U.S. Treasuries were financed in the bilateral repo market, on average, over the three reporting dates in the first quarter of 2015. During the same period, $711.5 billion of U.S. Treasuries were used as collateral or borrowed by the reporting firms (see the OFR Brief). To put this in context, $416.4 billion is equivalent to nearly a quarter of the primary dealer financing referenced earlier—a very significant proportion, despite the limited scope of the pilot program.  While the pilot data are helpful in estimating the point-in-time size of the bilateral repo market, officials are considering a more permanent data collection process to close this data gap for a large segment of the overall market.
Treasury Repo “Specials”: A security is said to be trading “special” in repo if it is trading at a rate below that of the tri-party GC rate.  That is to say, specials' trading indicates that a specific security is particularly sought after in the repo market, as cash lenders are willing to accept a lower rate for this specific security.  Because specials necessarily involve a specific security, instead of any security acceptable on a tri-party platform as general collateral, repo specials trading is part of the bilateral repo market.  As the following chart illustrates, the aggregated volume and typical pricings (volume-weighted average price, VWAP) in on-the-run, or current-issue, nominal coupon specials have been range-bound over the past six years.
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Source: BrokerTec and Treasury
There have been instances in which individual securities trade deeply special in repo.  This occurred, for example, in March 2016 ahead of the first reopening of the 10-year note, although, as the chart above shows, the overall average was not significantly affected.  Although the 10-year note did trade deeply special (near the current “fails charge” of -2.75 percent) for several days, the pricing was not out of line with recent precedent.  The following chart focuses on four highly similar occurrences over the past five years.  In the days leading up to the auction reopening, some market participants sell the security ‘short’ in an effort to clear balance sheet in anticipation of the imminent additional supply.  If, however, a preponderance of investors in that security is unwilling to lend it in repo, that security could trade deeply special for a time.  Once the additional supply settles, the repo specialness typically subsides, as evidenced by the following graph.
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Source: BrokerTec and Treasury
Direct Repo Trading: Some market participants have suggested that direct repo trading (i.e., without the typical role of a dealer acting as intermediary between the end cash lender and end cash borrower) could be an alternative means of increasing the supply of repo.  Although it is a small proportion of the overall market at present—about 3 percent of MMF Treasury repo investments as of June 30, 2016—there are signs that this non-traditional form of repo participation is increasing.  For example, MMFs have significantly increased their exposure to direct repo participants over the past year, as seen in the graph below.
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Source: SEC and Treasury-OFR
Concluding Thoughts:  The repo market supports trading activity in cash Treasuries by facilitating market participants’ ability to intermediate between buyers and sellers.  As such, the health of both the primary and secondary markets for Treasury securities is tied to that of the repo market.  The fact that repo volumes and pricing have remained within a relatively stable range in recent years demonstrates that, while the market has witnessed a number of changes, the Treasury repo market—like the Treasury market overall (see the first and second blog posts in this series)—continues  to function well .
James Clark is the Deputy Assistant Secretary for Federal Finance and Tom Katzenbach is a financial analyst in the Office of Debt Management at the U.S. Treasury Department.  The authors thank Viktoria Baklanova, a senior financial analyst in Treasury’s Office of Financial Research, for her valuable insights on the Treasury repo market.
Posted in:  Fixed Income
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