What is general collateral, specific collateral and special collateral in repo?
What is general collateral (GC), specific collateral and special collateral in repo?
General collateral (GC)
1 Repo is used to (1) borrow and lend cash or (2) borrow and lend securities, both on a secured basis. When a repo is being used as a means of borrowing and lending cash, Buyer will require sufficient collateral of acceptable quality. However, where more than one issue of acceptable quality is available, there is no reason for Buyer to demand a particular issue of securities and, in practice, Seller proposes which issue should serve as collateral. Where this is the case, the alternative acceptable issues can be regarded as substitutes for each other in the role of collateral. This means that they should trade in the repo market at the same or similar repo rate. Issues trading at the same or similar repo rate, because they are substitutable, are called general collateral or GC. The set of GC issues is often called the GC basket. The repo rate at which GC trades is called the GC repo rate.[1]
2 Given the substitutability of GC, there is no reason why the choice of one security issue over any other should influence the GC repo rate.[2] This rate should therefore largely reflect the supply and demand of cash, and it might be described as cash-driven.
3 GC is usually limited to securities issued by a central government, since only central governments typically issue enough securities to provide a set of substitutes.[3]
4 The default-risk-free nature of central government securities means that the repo rate on transactions against this type of GC represents the near-risk-free cost of cash, which makes the rate of particular interest to central banks monitoring monetary conditions and to banks benchmarking the cost of credit to other institutions.
5 GC repo is part of the money market, alongside alternative means of short-term borrowing and lending such as interbank deposits. This means that the GC repo rate should be closely correlated with other money market rates. The spread between the GC repo rate and unsecured money market rates should reflect the credit and liquidity risk premia on unsecured borrowing and lending.
6 In addition to near-risk-free GC --- that is, composed of government securities --- the market talks about other categories of GC composed of riskier securities, eg “credit GC”. Given that it is only governments who typically issue enough securities to provide a homogenous set of substitutes, non-government GC baskets have to be made up of collateral from more than issuer and acceptability has to be defined in terms of general criteria such as minimum credit rating. However, the mix of issuers makes it difficult to achieve a wider consensus on what are substitutes. Non-government GC baskets therefore tend to be bespoke to a particular pair of counterparties. This is typical of tri-party repo baskets.
7 Sometimes, consensus can be achieved among a small group of potential counterparties. This happens in GC financing facilities, although the heterogeneity of issuers is often ameliorated by the issues being eligible for central bank purchases or qualifying as HQLA. This means they are often high-grade collateral such as supranational issues, covered bonds, high-quality MBS and investment-grade corporate bonds.
Specific and special collateral
8 From time to time, parties seek to borrow a particular issue of securities in the repo market. Such repo can be said to be against specific collateral.
9 If demand for a specific security is strong enough and/or supply is weak enough, bidding pressure will force down the repo rate on that particular issue. In other words, competition between potential buyers will encourage them to offer cheaper cash to potential sellers. When the repo rate quoted on a particular issue falls sufficiently below the GC repo rate for the same currency and term, the issue in question is said to have gone special.[4]
10 Given that the repo rate for transactions against special collateral reflects the demand for and/or the available supply of particular securities, special repo is sometimes described as being securities-driven.
11 When the GC repo rate is low, and/or demand is very strong for a specific security, it is possible for specials to trade at negative repo rates, even when other interest rates are positive.
12 The spread between the GC repo rate and the repo rate on a special should reflect the strength of demand for and/or available supply of a particular security. Other things being equal, the specialness should be equal to the borrowing fee that would have to be paid to borrow that same issue in the securities borrowing/lending market.
[1] In fact, GC repos do not trade at precisely the same repo rate, because of differences in the contractual terms of repos. When reference is made to the GC repo rate, it has conventionally been the highest GC repo rate at the same tenor.
[2] However, the aggregate supply of and demand for acceptable collateral will influence the GC repo rates.
[3] In the US, GC also exists in Agency MBS and Agency debentures, as these are issued in large numbers.
[4] It has been convention in the market to require a repo rate to fall a clear 10 or more basis points below the GC repo rate before declaring it as special.