The Federal Reserve Bank of New York's "Liberty Street Economics" blog published the article, "Investigating the Proposed Overnight Treasury GC Repo Benchmark Rates," which reviews several repo benchmarks. Written by Alexandra Altman, Kathryn Bayeux, Marco Cipriani, Adam Copeland, Scott Sherman, and Brett Solimine, the piece says, "In its recent "Statement Regarding the Publication of Overnight Treasury GC Repo Rates," the Federal Reserve Bank of New York, in cooperation with the U.S. Treasury Department's Office of Financial Research, announced the potential publication of three overnight Treasury general collateral (GC) repurchase (repo) benchmark rates. Each of the proposed rates is designed to capture a particular segment of repo market activity. All three rates, as currently envisioned, would initially be based on transaction-level overnight GC repo trades occurring on tri-party repo platforms."
The blog explains, "The first rate would only include transactions in the tri-party repo market, excluding both General Collateral Finance Repo Service, or GCF Repo, transactions and Federal Reserve transactions. (GCF Repo is a registered service mark of the Fixed Income Clearing Corporation.) Henceforth in this post, this segment will be referred to as tri-party ex-GCF/Fed. The second rate would build on the first by including GCF Repo trading activity while still excluding Federal Reserve transactions. Finally, the third rate would include tri-party ex-GCF/Fed transactions, GCF Repo transactions, and Federal Reserve transactions."
It continues, "The repo benchmark rates would be calculated as volume-weighted medians, as is currently the case for the production of the effective federal funds rate (EFFR) and the overnight bank funding rate (OBFR), and would be accompanied by summary statistics. The three proposed rate compositions result from staff analysis on the various market segments and characteristic trading behavior, though the New York Fed expects to work with the Board of Governors of the Federal Reserve System to seek public comment on the composition and calculation methodology for these rates before adopting a final publication plan."
Regarding its goals, the NY Fed economists write, "The principal driver behind the potential publication of overnight Treasury GC repo benchmark rates is to enhance market transparency and efficiency by improving the quality and breadth of repo market information available to the public. Currently, little rate information is available on the repo market. Among the information that does exist is the Bank of New York Mellon (BNYM) Treasury Tri-Party Repo Index, or "Treasury TRIP," which reflects the average rate on all overnight Treasury-collateralized repo transactions cleared on BNYM's platform, including the Fed's overnight reverse repurchase (RRP) trades. In addition, the Depository Trust and Clearing Corporation (DTCC) publishes aggregated daily rate and volume data for the GCF Repo market in its own Treasury index."
The blog tells us, "The currently proposed repo benchmark rates differ from both the BNYM and DTCC indexes in several important ways. First, two of the three new proposed rates would exclude Fed transactions, thereby providing focused insight into market-determined collateralized funding rates. Second, consistent with best practices for financial benchmarks, the New York Fed plans to exclude trades that are conducted between affiliated entities.... The increased transparency provided by these rates would support the New York Fed's primary objective of improving publicly available information on the repo market, and may support ongoing work by the Alternative Reference Rates Committee (ARRC)."
The NY Fed's update states, "In the United States, the repo market is primarily subdivided on the basis of settlement platform. `In the tri-party repo segment, transactions are negotiated between the cash lender and the collateral provider, while a third-party clearing bank acts as an intermediary by managing clearing and settlement of the trades. For bilateral repo transactions, however, the two institutions on either side of the repo contract and their respective custodian banks manage all aspects of trade settlement. The benchmark rates that the New York Fed proposes publishing are anticipated to rely only, at the outset, on transactions in the tri-party market, since robust data on the bilateral repo market are currently unavailable."
Finally, it adds, "Within the tri-party market, there are three distinct sub-segments: tri-party ex-GCF/Fed, GCF Repo, and tri-party activity with the Federal Reserve. The segments are differentiated by the type of activity and the market participants.... The chart below shows the behavior between August 2014 and October 2016 of the three proposed GC repo benchmark rates. During the sample period, the three rates tracked each other closely, with each rate showing exactly the same value on 60 percent of the days.... In contrast, the tri-party including GCF Repo/Fed rate has been slightly lower than the tri-party including GCF Repo rate on financial statement dates, given that more activity flows into the overnight RRP on those dates."
In other news, Wells Fargo Securities recently published, "The Curious Case of the Discounted Callable," which explains, "The impact of money market fund reform hits markets in many different ways. We know of its impact in repo markets, in Treasury bill markets, in commercial paper markets, in bank CD markets, but we hadn't really seen its impact in Agency callable markets, or maybe we simply hadn't recognized it."
It adds, "It is no secret that government money market fund assets under management (AUM) have risen by approximately $1 trillion since the beginning of 2016. With that increase in government fund AUM comes a significant increase in the demand for government securities.... As a result of the increased demand for money market government securities, the GSEs have shifted their funding mix away from callables and towards short-term floaters and discount notes. To provide some context to the magnitude of the change in cost for callable funding relative to money market funding over the past six months, Exhibit 2 illustrates the estimated new issue spread to LIBOR for agency discount notes and swapped callables."
Wells Fargo continues, "With the current lack of callable supply and new issue callable spreads trading very close to agency bullets, slightly seasoned callables have begun to trade at a decent discount to par and may offer an interesting alternative to both new issue callables and bullets. For buy-and-hold investors, the yield on discounted callables is generally higher than maturity-matched bullets and new issue callables (i.e. par bonds)."
The piece explains, "One benefit of buying a discounted callable is that the additional spread to bullets is less attributable to the embedded call option. As a result, the discount callable is less likely to be called, has upside price potential, and has a higher book yield and total return than a maturity-matched bullet as rates rise.... It should be noted that in a falling interest-rate environment the bullet outperforms the discount callable, while in a flat-to-rising rate environment the discount callable outperforms the bullet."
It says, "If an investor's view is for rates to remain relatively range bound, a discount callable may achieve a higher holding-period return than a maturity-matched bullet or a par callable. If the outlook is for rates to rise, the discount callable has a higher book yield and holding-period return than a maturity-matched bullet. Should rates fall, the discount callable achieves a higher holding-period return than a par callable due to the accelerated repayment schedule of the discount."
Finally, Wells piece tells us, "Given the overall lack of supply in the new issue callable market, we see secondary discount callables as an alternative that can provide a bullet buyer with the potential for greater returns in a rising rate environment, and limited optionality versus a new issue callable in a falling rate environment. For the callable buyer, there is an opportunity for price appreciation in a product where price appreciation does not typically exist, coupled with available supply for investors that have found new issue investment alternatives relatively scarce."
