The Repo Market – A Background

Initially repo was the domain of the U.S. Federal Reserve, although investment banks started using their securities holdings as collateral to obtain financing on favourable terms following the introduction of the Glass Steagall Act in 1933, a landmark piece of legislation which imposed a ban on banks utilising client funds for the exact same purpose. 

Historically dominated by the US, repo markets began to emerge in other major economies (i.e. the UK, Japan, Germany, Switzerland) during the mid to late 1990s. In the case of Switzerland, repos came into being after the abolition of the federal stamp tax on turnovers in 1998.  Repos today play a vital role in the smooth functioning of global markets and their significance is only expected to trend upwards.

Enabling Markets to Operate Efficiently

Repos are a financing tool, and they serve many purposes. Through repos, market participants can obtain the necessary securities or cash to be deployed in other transactions, such as posting margin.

Alternatively, securities borrowed via repos can help market participants meet their settlement obligations. “Where an intermediary has sold securities to one party, which it has purchased from another, but the inward delivery fails to arrive on time, the intermediary can borrow those securities in the repo market to ensure that it can make timely delivery. Without the ability to borrow securities, delivery failures might propagate through the market,” according to a report by the International Capital Market Association (ICMA). [1] With more markets shortening their settlement cycles from T+2 to T+1, the role of repos will become increasingly important for firms, if they are to avoid trade fails.

Repos can also be used by financial institutions to hedge interest rate exposures, cover short sales and build up leveraged positions. A hedge fund, for example, might turn to the repo market to finance a trade designed to benefit from a mispricing of risk - which in turn will facilitate better price efficiency in the underlying cash markets.[2]

A Tool in the Central Bank Toolbox

Central Banks are major participants in repo markets too and make use of this financial tool in their daily activities.

ICMA notes that the collateralised nature of the repo market reduces Central Bank’s credit risk, and also allows for the use of a wider range of assets beyond outright purchases.[3] This lets Central Banks execute their monetary policies seamlessly during periods of calm, while simultaneously enabling them to respond more quickly to major crises.[4]

Repos have played an invaluable role in insulating markets from recent bouts of turbulence (i.e. COVID, deteriorating geopolitical tensions, etc.) over the last few years. In particular, repos were a conduit for Central Banks to provide much-needed liquidity to financial markets during the early stages of the COVID pandemic, and following Russia’s invasion of Ukraine two years later.

During both crises, the European Central Bank (ECB) used repo lines to provide extensive euro liquidity to a number of non-euro area Central Banks, helping to prevent further market turmoil and contagion seeping into the euro-area. With markets looking increasingly unpredictable, repos will continue to be leveraged by Central Banks in the months and years ahead.

An Effective Investment Model

Reverse repos are widely seen as being a low risk and highly liquid investment tool for financial and non-financial institutions (i.e. money market funds, asset managers, financial market infrastructures, corporates, etc.), which are sitting on surplus cash piles. At a time when return generation is proving difficult, the repo market helps lenders net incremental income, while giving borrowers access to cheaper funding.

Switzerland and Repo

Repos are used extensively in Switzerland.

For instance, the Swiss National Bank (SNB) engages in repo transactions to ensure that the secured short-term money market rates in Swiss Francs remains close to the SNB policy rate, and also as a means to provide and absorb liquidity.[5] According to the SNB, the volume of securities eligible for SNB repos totalled CHF 11.4 trillion at year-end 2022.[6]

A Lot of This Activity Is Being Facilitated by SIX

CO:RE is a sophisticated multi-currency trading platform, built and operated by SIX, which enables banks, broker-dealers, insurers and commercial banks to increase efficiency, reduce risk and manage costs. It supports liquidity by giving users access to SNB and commercial bank money, together with primary SNB money market auctions.

Today, one third of participants using SIX Repo are based outside of Switzerland, and there are currently 14 currencies being traded on the CO:RE platform. As domestic repo volumes keep growing and the currency trading pool deepens beyond just Swiss Franc, so too will the number of international institutions participating in the market, as they try to obtain High Quality Liquid Assets (HQLA) in what has become an increasingly capital constrained world.