Follow the Cash! Microstructure of Repo Markets

Repurchase agreements, commonly known as repos, are a key component of the U.S. money markets, with daily volumes exceeding $13 trillion. These transactions involve the sale of securities, typically U.S. Treasuries, for cash with an agreement to repurchase the securities later, usually the next business day. Collateral plays a crucial role in repo transactions, attracting a diverse range of participants and allowing for customization in terms, rates, maturities, and security types.

Dealers act as intermediaries in the repo market, connecting cash-rich investors, such as money market funds (MMFs), with cash borrowers, often hedge funds. Dealers earn a spread for their intermediary services, creating value by managing counterparty, collateral, and maturity transformation risks. They also play a vital role in the interdealer market, where most trades clear through a central counterparty, providing benefits like netting positions, anonymity, and reduced counterparty risk.

However, these advantages come with added costs, such as fees for default fund contributions and higher margining requirements.

Money market funds, as the primary cash lenders, utilize repos to manage client redemptions and meet regulatory requirements. Government MMFs, which dominate the market, are restricted to investing in cash, U.S. government securities, and repos backed by U.S. government collateral. The repo market's unique structure and processes enable efficient cash and collateral flow, benefiting various market participants while managing associated risks.