Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

How Do European Sovereign Debt Repos Work Anyway?

Euros at an angle
Thomas Northcut | Photodisc | Getty Images

By now you know that MF Global was using repo-to-maturity trades to pick up nickels until it got crushed by a collateral call steamroller.

I’m planning on writing more about this trade and the accounting that goes into it. But I’d really like to know more about how it works mechanically. I’ve asked around but none of my usual sources has any clue.

In a traditional repo involving Treasury or federal agency bonds, everything happens over Fed wires.

The transfer of the bond and funds happen simultaneously at the local Federal Reserve bank—usually the Federal Reserve Bank of New York. As in so many modern banking transactions, nothing actually moves. One electronic account is credited with the bonds and debited the cash and the other credit with the cash and debited the bonds. At maturity, the wires transfers are reverse.

Of course, most firms do not have direct access to the Federal Reserve’s securities and payments transfer systems. So it is not their accounts the Fed is crediting or debiting. It is the account of the depository institution acting as a clearing agent for their customers.

Of course, that kind of repo has largely been displaced by the tri-party repo—which was a natural extension of the bilateral repo between clearing banks.

In a tri-party repo, there are no more transfers over the Fed wires. In the place of the Fed you have one of the banks appointed at a primary dealer acting as the “tri-party agent.” That agent acts just like the Fed, crediting the account of the seller-borrower with cash and debiting the bond from his account, while simultaneously crediting the account of the buyer-lender with the security and debiting the cash.

(The details of all this are pretty interesting. You can read more in this white paper from the Fed.)

What I’m not sure about is how this works with US firms repo-ing bonds issued by European governments. For one thing, where do the underlying bonds “exist”? Presumably, they are electronic book-keeping entries on a database somewhere. Is this with the ECB or the various national banks?

Do most of these transactions take place through a tri-party system or bilaterally? Who are the biggest clearing banks for this kind of thing? Who, in particular, was clearing MF Global's trades?

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