Journal of Financial Market Infrastructures

Risk.net

Benefits and risks of central clearing in the repurchase agreement market

Viktoria Baklanova, Ocean Dalton and Stathis Tompaidis

  • The repo market is a major source of short-term funding in the financial system.
  • Many repo transactions between dealers are centrally cleared.
  • Expanding central clearing to transactions between dealers and nondealer clients increases the benefit to dealers.
  • Expanding central clearing also increases the risks to the central counterparty.

Recent regulatory changes have raised the cost of activity in the repurchase agreement (repo) market for bank-affiliated dealers. Many transactions between dealers are centrally cleared. Expanding the use of central clearing to transactions between dealers and nondealers could reduce costs and improve market access for market participants. But what are the trade-offs? Data from the Office of Financial Research’s interagency bilateral repo data collection pilot indicates that dealers could reduce their risk exposures if repo transactions conducted by nondealer clients were centrally cleared. However, this would also increase the potential risks that central counterparties themselves face from larger exposures.

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