Fundamental to Guaranteed Repo is the role of guarantor banks. In this solution, banks guarantee all-to-all secured funding transactions, thereby maintaining their role as credit intermediaries An additional benefit of this guaranteed structure is that it allows banks to reduce risk-weighted assets and balance sheet usage - which can enhance the return on their equity and assets, allowing them to more readily support repo market activity.
The schematic (on the right) shows how a guarantor bank serves as an anchor for all other parties in repo market transactions, including end users of cash and collateral, end provider and custodians. Guarantees from highly rated banks allow end users to face end providers while maintaining the quality of credit exposure. Banks earn fees for providing guarantees to support the performance of end users. End users include hedge funds, Liability-driven Investors (LDIs) and Real Estate Investment Trusts (REITs). End providers include regulated money market funds, state and local governments, pension plans and insurance companies.
Figure 1 above illustrates the workflow using the Guaranteed Repo model
Euroclear manages collateral for both end users and end providers, handling services such as settlement instructions, substitutions, margining and maturities. Euroclear facilitates settlement of transactions on a delivery vs. payment basis, using existing settlement locations such as Fedwire in the United States and CREST in the United Kingdom; it can accommodates overnight and term transactions. Cost savings
Guaranteed Repo reduces settlement costs for participants by causing collateral and cash to be exchanged directly among end users and end providers, eliminating the additional movement of collateral to intermediary banks in the “matched book” two-step settlement model.
Backstop liquidity
Guaranteed Repo does not require backstop liquidity commitments from users. The cost of backstop liquidity commitments can be high for banks and can limit the benefits of participating in cleared repo models.
