Treasury Takes Action to Penalize Repo Fails; Hedge Funds Could See Higher Charges, Less Availability of Treasuries as a Result
Hedge Fund Law Report
In an effort to reduce the likelihood of fails in the repurchase agreement (repo) market, the Treasury Market Practices Group (TMPG), an industry body sponsored by the Federal Reserve Bank of New York, has imposed a three percentage point fee on investors in the repo market who fail to deliver borrowed Treasuries on time. The TMPG action is designed to increase market efficiency. According to a statement issued by the TMPG, “[s]ince November, short-term interest rates have declined to unprecedented levels, increasing the urgency to implement new practices to enhance liquidity and improve functioning of the U.S. Treasury market. Accordingly, the TMPG focused on the fails charge recommendation as the most immediate and meaningful way to improve Treasury market functioning and liquidity.” However, while the charge is meant to increase market liquidity, it could ultimately have the reverse effect: the fee is likely to make Treasuries scarce as the owners of these securities become reluctant to lend and instead opt to hold onto them. We define a repo transaction and discuss the TMPG action, hedge funds’ participation in the repo market, the reasons for and frequency of repo fails, whether the fee is high enough to deter fails and the impact of the TMPG action on the current market.