RepoMech: A Method to Reduce the Balance-Sheet Impact of Repo Intermediation

TL;DR

This paper introduces RepoMech, a novel method for multilaterally netting repo trades that reduces balance-sheet impact without changing counterparty risk, addressing regulatory and accounting challenges post-2008 crisis.

Contribution

RepoMech provides a new multilaterally netting approach for repos that avoids shifting counterparty risk and mitigates regulatory and accounting constraints.

Findings

Reduces balance-sheet impact of repo trades.

Maintains original counterparty risk structure.

Potentially lowers trading costs and regulatory burdens.

Abstract

A repo trade involves the sale of a security coupled with a contract to repurchase at a later time. Following the 2008 financial crisis, accounting standards were updated to require repo intermediaries, who are mostly banks, to increase recorded assets at the time of the first transaction. Concurrently, US bank regulators implemented a supplementary leverage ratio constraint that reduces the volume of assets a bank is allowed record. The interaction of the new accounting rules and bank regulations limits the volume of repo trades that banks can intermediate. To reduce the balance-sheet impact of repo, the SEC has mandated banks to centrally clear all Treasuries trades. This achieves multilateral netting but shifts counterparty risk onto the clearinghouse, which can distort monitoring incentives and raise trading cost through the imposition of fees. We present RepoMech, a method that avoids these pitfalls by multilaterally netting repo trades without altering counterparty risk.