The Treasury Market Practices Group (TMPG), a New York Fed-sponsored group of market professionals, recently released a white paper and proposed recommendations on margin practices for repurchase agreements, or repos, involving U.S. Treasury securities. The white paper, based on discussions with market participants and data from the U.S. Treasury Department’s Office of Financial Research, describes the current risk management practices in the Treasury repo market for mitigating counterparty risk exposures, or the potential losses from a counterparty defaulting before final settlement of a financial transaction. It also identifies the resulting risk and resiliency issues. Based on this work, the proposed updates to the TMPG’s Best Practices include a recommendation that all Treasury repo trades should include prudent haircuts, or margin, on the value of the securities, in concert with other risk management techniques. In this article, we highlight the main findings of the white paper that led to this proposed best practice recommendation, with a focus on the non-centrally cleared bilateral repo market.
Treasury Repo Market 101
A repo is a financial transaction between market participants, in which one sells a security in exchange for cash on a specific date, with the promise to repurchase the same security for a specific price on a future date. Treasury repo, or the repo market in which Treasury securities are exchanged for cash, is used to secure funding and provide liquidity for Treasuries in the secondary market. As such, it is critical for the functioning of the U.S. financial system.
Concerns about repo market resilience have emerged during times of stress, such as the October 15, 2014 flash crash in the Treasury market, the Treasury repo rate spikes in September 2019, and the Treasury market dysfunction in March 2020. In response, the TMPG has completed studies on the clearing and settlement risks of Treasury securities, including this latest white paper, and proposed best practice recommendations, which can be found on the TMPG website.
The Treasury repo market currently includes four main segments, each defined by whether transactions are centrally cleared or not and whether they’re settled bilaterally or by a third party. The white paper looks at risk management practices in the Treasury repo market, with an emphasis on two of its segments. The first segment, and focus of this article, includes non-centrally cleared bilateral repo (NCCBR) trades, or dealer-to-client repo trades which are settled outside of the tri-party repo settlement system and are not centrally cleared. The second segment includes dealer-to-client repo trades which are indirectly centrally cleared.
Current Risk Management Practices in the Non-Centrally Cleared Bilateral Repo Market
Despite the high quality of securities in Treasury repo and the typically short maturity of these trades, they can create counterparty credit exposures. These exposures reflect the probability of a counterparty failing to deliver securities or cash in a transaction, as well as the liquidity and market risks of the securities exchanged.
Although the tools to manage these exposures differ across repo market segments, the haircut, a measure of the relative value of the cash principal to the value of securities exchanged, is commonly used. For example, in tri-party repo, a segment where dealer-to-client trades are cleared and settled on a tri-party settlement platform, the vast majority of trades include a haircut to manage counterparty credit exposures (see data on haircuts in tri-party).
In part due to the opaqueness of the NCCBR segment and the various types of financial firms active in it, it is difficult to characterize the main tools used by market participants to manage their counterparty credit exposures. From discussions with market participants and the data collected from two Office of Financial Research pilot surveys (see the 2015 Bilateral Repo Pilot and 2022 NCCBR Pilot), a majority of NCCBR transactions involving Treasury securities have zero haircuts, meaning that on the initial settlement leg of the repo, the value of cash principal is equal to the value of the securities exchanged.
For some of these transactions with zero haircuts, counterparty credit exposures are managed using other tools, such as position limits, netting agreements, and/or portfolio margining. But there are likely market participants, perhaps yielding to competitive pressures, who do not charge a haircut or collect margin on these trades. Rather, the counterparty credit exposures from these trades may be accepted as the cost of doing business in this segment.
Resulting Risk and Resiliency Issues in the NCCBR Market
In the NCCBR market segment, the lack of consistency and transparency in risk management practices to manage counterparty credit exposures is a risk, according to the TMPG white paper. This inconsistency, along with the competitive forces in this segment, could be driving risk management to become a commercially negotiated term in some transactions. Such a development is likely to drive some market participants away from prudent risk management, which poses a risk not just to the participant, but also potentially to the market. This broader risk would result from the different risk assessments being largely opaque to market participants, making them hard to recognize and properly manage.
Updating Best Practices for the NCCBR Market
To address these risks, the TMPG proposes updates to its best practices, which state that all Treasury repo trades should include prudent haircuts (or margin), in concert with other risk management techniques. The haircut should reflect the counterparty credit risk from the trade, as well as the liquidity and market risks of the securities being delivered.
To Sum Up
The TMPG white paper found that the risk management practices in the NCCBR segment lacked transparency and consistency, and so posed risks to the broader repo market. As a result, the TMPG proposes updating its best practices to recommend that all Treasury repo trades include prudent haircuts (or margin), with other risk management techniques. The TMPG is currently accepting feedback on both its white paper and proposed updates to best practices through April 30, 2025 at tmpg@ny.frb.org.
Adam Copeland is a financial research advisor in Capital Markets in the Federal Reserve Bank of New York’s Research and Statistics Group.
Ellen Correia Golay is a capital markets trading advisor in the Markets Group.
Agata Zhang is a policy and market analysis principal in the Markets Group.
The views expressed in this article are those of the contributing authors and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
