Pledge repurchase is a common form of trading in the financial market, which is designed to meet the short-term funding needs of financial institutions.
1. Definitions
Pledged repurchase agreement, referred to as pledge or repurchase, refers to the transfer of a certain asset (usually bonds, etc.) held by a financial institution (such as a bank, brokerage, etc.) to other financial institutions by pledge, and at the same time reach a repurchase agreement to repurchase the asset at an agreed time and in the future. This form of transaction is actually a form of collateral financing, where short-term funding is obtained by pledging assets.
1.Objective. Provision of short-term funds: Pledge repo lending is a common means for financial institutions to obtain short-term funds, which is conducive to meeting their liquidity needs. By pledging assets to other financial institutions, the pledgee can obtain funds to address short-term funding gaps.
Balance sheet adjustment: Pledge repurchase can help financial institutions optimize their balance sheet structure and adjust their risk exposure. By turning certain assets into collateral, financial institutions can reduce their risk exposure and optimize asset allocation to improve profitability.
2.Participants.
Pledgee: A financial institution acts as a pledgee to pledge a certain asset held by itself. The pledged assets are usually financial assets with a certain market value and liquidity, such as bonds.
Repurchaser: The financial institution acts as the repurchaser, providing short-term funding and entering into a repurchase agreement. While providing funds, the repurchaser obtains the assets of the pledgee as collateral to ensure the security of the transaction.
Second, the operation process
1.Negotiate transaction conditions: The pledgee and the repurchaser negotiate to determine the transaction conditions such as the pledge period, interest rate, and type of pledged items, and sign relevant agreements. The agreement on these transaction conditions is essential for the protection of the rights and interests of both parties to the transaction and risk control.
Pledge period: Agree on the time frame for the repurchase of pledged assets. Usually, the staking period is shorter, generally between a few days and a few months.
Interest rate: Agree on the interest rate to be paid by the repo to the staker. The determination of interest rates is usually related to the level of market interest rates and the bargaining power of both parties to the transaction.
Types of collateral: Usually financial assets such as bonds. The type and quality of the collateral have a certain impact on the risk tolerance and liquidity needs of the repurchaser.
2.Asset pledge: The pledgee pledges the assets held by the pledgee and transfers them to the repurchaser in accordance with the agreed proportion as collateral for the transaction. The proportion of pledge transactions is generally between 80% and 95%, and the specific proportion needs to consider factors such as the market value and liquidity of the pledge.
3.Fund Withdrawal: The repo provides short-term funds to the pledgee as financing for the pledgee**. The funds lent can often be used to meet the liquidity needs of stakers and support their day-to-day operations and business development.
4.Repurchase agreement: At the same time as providing funds, the pledgee and the repurchaser reach a repurchase agreement, stipulating that when the pledge period expires, the pledgee will repurchase the assets at the agreed ** and pay the corresponding interest expenses. The content of the repurchase agreement includes the repurchase date, repurchase ** and other terms.
5.Pledged asset repurchase: At the agreed time and **, the pledgee will repurchase the assets and pay the corresponding interest expenses to the repurchaser. After the repurchase is completed, the pledgee retrieves the collateral and the transaction is completed.
3. Risk and supervision
1.Market Risk.
Market risk is one of the important risks faced by pledged repurchase and lending exchanges. This risk may be affected by factors such as changes in market interest rates, liquidity pressures, etc., resulting in an increase in the cost of funds or the value of the asset of the staker**. Specifically, market risk may include the following:
Interest rate risk: Due to fluctuations in market interest rates, stakers may face the risk of increased cost of funds when conducting repurchases. In particular, if the market interest rate rises, the interest expense paid by the staker when buying back the asset will also increase, increasing its financing costs.
Liquidity risk: In the case of tight market liquidity, the staker may face the risk of difficulty in repurchasing assets, resulting in inefficient use of funds or loss of funds.
2.Counterparty default risk.
Another important risk is the risk of counterparty default, that is, the repurchaser is unable to repurchase assets as agreed, resulting in the loss of funds on the pledge. To reduce this risk, parties to a transaction can take the following steps to manage their risk:
Guarantee measures: The repurchaser may be required to provide collateral or purchase guarantee from a third-party institution to reduce the losses caused by the counterparty's default.
Set risk limits: The pledgee can set a risk limit based on the credit status and financial strength of the repurchaser to limit the transaction size of a single repo, so as to diversify and control the default risk of the counterparty.
3.Regulatory measures.
In order to ensure the security and transparency of transactions, the relevant regulators need to strengthen the supervision of pledged repo and split transactions, and formulate reasonable guidelines, rules and risk management measures to reduce systemic risks. At the regulatory level, the following measures can be taken:
Establish reasonable rules and guidelines: Regulators should formulate rules and guidelines for pledged repo and split transactions, including trading standards, disclosure requirements, and risk management requirements, to ensure compliance and transparency of transactions.
Strengthen regulatory review: Regulators should strengthen the review and supervision of financial institutions' participation in pledged repurchase and lending transactions, including the review of the use of funds, risk management capabilities and information disclosure, so as to reduce potential violations and hidden risks.
Timely adjustment of regulatory policies: Regulators should pay close attention to market dynamics and adjust regulatory policies in a timely manner to adapt to the development and changes of the financial market. This includes flexibly adjusting regulatory policies according to market risk conditions and the behavioral characteristics of financial institutions, so as to improve the pertinence and effectiveness of supervision.