Money Markets

Repurchase Agreements


Repurchase agreements ("repos" for short) are contracts involving the simultaneous sale and future repurchase of an asset, most often treasury securities. Under the terms of the agreement one party sells the securities and agrees to buy them back at a price that reflects the funding rate associated with the underlying security. As such, repos represent an instrument whereby one can invest short-term cash in high yielding securities while incurring minimum risk. RBC CM is able to offer repo markets in government bonds from the followings countries: Australia, Canada, European Union, New Zealand, United States and the United Kingdom.


The Product


The repos were originally developed by US securities houses who had a requirement to fund their natural long positions in fixed income securities. As their credits on a stand-alone basis did not allow them to borrow at attractive levels the idea of pledging collateral out of their long position gained hold. The market has grown dramatically and now constitutes a very attractive investment alternative to other short-term investments.


The Canadian repurchase market has grown dramatically with the amending of the withholding tax in May 1993. Estimates of the market's size range up to C$100 billion outstanding on a daily basis with a daily turnover of C$20 billion. Terms for repurchase agreements range from overnight to one year; however the best liquidity in the market exists out to three months. Forward dated trades are also gaining popularity, driven by the arbitrage activity between the Repurchase market and derivatives such as the BAX and FRA's.


A typical repurchase transaction might involve RBC Capital Markets selling $25 million 5 year Government of Canada bonds to one party while simultaneously contracting to repurchase these bonds in two days at an agreed price. During this period the repo purchaser acquires title to the securities, while earning a competitive return on his cash balances.


The repurchase transaction can also be used to acquire specific securities for a short-term basis. For example an account might require to borrow a specific bond which it has shorted in the cash market in order to make proper delivery. As such, the account could then negotiate a repo rate and term in order to acquire this specific bond from RBC Capital Markets' fixed income inventory.


The previous example highlights the market for "special" repo rates. Under this situation the notable feature of the repo transaction is the supply and demand for the underlying security. The market for "special" repo has its own specific factors which influence the pricing of the instrument. Moreover, the market for special repo generally diverges from the general trend in short-term interest rates. This repo market displays considerable volatility, and consequently, can be used as another instrument to capture capital gains in taking advantage of one's views on the future direction of special repo rates or by anticipating which fixed income issues will soon trade "special" in the repo market. 

Advantages of Repurchase Agreements with RBC Capital Markets


Security of capital: The combination of a credit worthy dealer such as RBC Dominion Securities Inc, and the use of Federal and Provincial collateral can greatly reduce the risks associated with these short-term investments.


Competitive rates of return: The repo rates are driven principally by the prevailing market interest rates that match the maturity range of the repo term and the underlying supply and demand conditions of the specific fixed income security. The repo rate does not depend on the yield offered by the underlying security. Additionally, the rates compare favorably to other money market yields while often outperforming the returns offered by term deposits.


Access to RBC Capital Markets inventory of fixed income products: As Canada's largest investment dealer, RBC Dominion Securities Inc. has an unparalleled inventory of fixed income products which can be structured to meet each repo counter-party's needs.


Liquidity: Repurchase agreements can be structured to meet the investor's needs, ranging from the most common overnight repos to maturities of up to one year. 

RBC Capital Markets Repurchase Agreement Program


Open repo: are term contracts where the continuity of the transaction is contingent upon a mutual agreement on the interest rate and term of the repurchase agreement.


Flex repo: is a term repurchase agreement that provides for principal drawdowns prior to its final maturity. The agreement being best suited for financings where there will be cash flow uncertainty and a need for a fixed reinvestment rate.


Index Repo: a term repo where the interest rate is reset periodically as a function of a short-term rate index. These repos can be a useful instrument for issuers of floating rate securities who wish to match their asset and liability book.

Settlement and Support Operations at RBC CM


Settlement of transactions are based on current bond/bill prices plus any accrued interest. The transaction is usually settled through CDS, but Euroclear and Cedel can also be used. Repurchases involving US government Securities settle through the Federal Reserve wire system.


RBC Capital Markets has one of the most efficient operations on the "street", achieved through a combination of experienced, highly professional staff and a total commitment to automation. Clients discover that this combination leads to a superior service level in terms of accuracy, reliability and timeliness. Whether we are dealing as a counterparty, as an agent, or as a Client's correspondent, freedom from operational concerns leaves more time for execution instead of problem resolution.


Credit Risk: The primary credit risk to the investor is that of the counterparty. As a result, Repurchases tend to be dominated by those institutions that have had a history of financial soundness. Should the seller of the Repurchase default on their obligation to repay the funds advanced by the purchaser, the purchaser legally has the right to set-off its liabilities by selling the asset into the marketplace. To minimize the counterparty risk, agreements are signed which provide for daily mark to markets on the underlying Repurchase collateral. Depending on the terms of the agreement, mark to market positions as little as C$100,000 can be demanded in the form of additional collateral or cash.


Documentation: Standard legal agreements are in use in most markets to cover the rights and obligations of both the purchaser and the seller. An agreement acts as blanket coverage as opposed to a requirement for a deal-by-deal reconfirmation. Finally, both the buy and sell side trade tickets are issued simultaneously, at the time of the trade, as confirmation.