A Brief Note on Tri-party Repos (TREPs)

Tri-party repos (TREPs) is a risk-free borrowing and lending of funds against government-issued securities by financial institutions, banks, mutual funds, etc. 

Introduced on November 5, 2018, TREPs is a tri-party lending system, that includes a borrower, a lender, and a tri-party agent, which acts as an intermediary between the two parties to the repo to facilitate services such as collateral selection, payment and settlement, custody and management during the life of the transaction.

First, repos or re-purchase agreement is a liquidity mechanism between two banks. Generally, banks are required to maintain their statutory liquidity ratio (SLR) and cash liquidity ratio (CLR) above certain limits. If there are mismatches, banks can use the repo market to ensure corrections.

For instance, let’s say, Bank A has surplus government securities (G-Secs), while Bank B has surplus cash. They enter into a repo agreement in which Bank A sells the G-Secs to Bank B in exchange for cash. The agreement has a built-in repurchase clause, that is, after a fixed time has elapsed the transaction will be reversed. In this case, Bank A will buy back the G-Secs from Bank B, in exchange for cash. 

As the G-Secs will have reduced in terms of value since the forward leg of the repo, Bank A will get lesser cash than what it paid in the first round. This ends up generating a return for Bank B on their idle cash.

Considering only G-Secs are dealt with in this system, there is no risk premium. Most of the transactions take place at the repo rate only.

Taking it further, TREPs only involve adding a broker between the two parties. The broker will ensure both legs of the repo go through smoothly, and fix the rates as well. 

Generally, this is how the Reserve Bank of India (RBI) enforces short-term rates (repo rates) in the market.

In a TREPs transaction, a party sells a treasury bill to another party with an agreement to buy it back on a mutually agreed future date at an agreed price. This also includes interest for funds that are borrowed. 

TREPs are undertaken through the Clearing Corporation of India Ltd (CCIL), which acts as a counterparty to all trades. 

Generally, TREPs are used to make loans for short-term periods, which could be overnight or up to a year. 

Markets regulator the Securities and Exchange Board of India (SEBI) has mandatorily directed mutual funds to invest at least 5% of their assets in liquid assets, including TREPS.

TREPS introduce quick liquidity, this ensures that they can be easily bought and sold in the money market. 

The returns on TREPS are directly related to the prevailing market conditions. This means that they can provide higher returns whenever interest rates are high.