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12. What is a ‘special’ in the repo market?
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A special is an asset that is subject to exceptional specific demand in the repo and cash markets compared with very similar assets. This causes potential buyers in the repo market to compete for the asset by offering cheap cash in exchange. A special is therefore identified by a repo rate that is lower than the GC repo rate (see question 11). The demand for some assets can become so strong that the repo rate on that particular asset falls to zero or even goes negative. The repo market is the only financial market in which a negative rate of return is not unusual.

Bonds trading ‘on special’ in the repo market will also be subject to exceptional specific demand in the cash market.*  Indeed, demand in the cash market is usually the reason why bonds trade on special in the repo market. Market-makers and other dealers will use the repo market to borrow bonds that are in strong demand in the cash market (and therefore sometimes scarce) in order to fulfil delivery commitments on sales of those bonds in the cash market. Where a bond is on special in the repo market, it will be more expensive to buy in the cash market compared to very similar issues.

When negotiating special repos, parties agree the collateral first and then the term, size and price of such transactions. The seller has no choice about which security to deliver as collateral.

One of the most common reasons for a bond to go special is when it becomes the cheapest-to-deliver in the futures market for that bond. Some futures sellers will have difficulty buying what they need to deliver to the futures clearing house. As failure to deliver to a clearing house would incur serious penalties, these parties will be forced to borrow the bond in the repo market and they may have to bid aggressively to secure the bond, including sometimes offering negative repo rates.

The term ‘special’ is often used incorrectly to describe any single security issue that the seller and buyer in a repo agree to use as collateral, as opposed to issues selected from a GC basket. This is not correct. A special is identified only by the fact that its repo rate is below the GC repo rate. Not all security issues specifically agreed as collateral between sellers and buyers trade at repo rates below the GC repo rate. Such issues could be called ‘specifics’ but should not be called ‘specials’. The latter form a subset of the former.

Note that the GC baskets created by an automatic repo trading system (ATS) or a central clearing counterparty (CCP) are not precise reflections of what is actually GC in the market. Because the contents of such baskets are fixed (or only infrequently changed), they are likely to contain issues that have gone special. On the other hand, they will not contain all the securities that are trading GC.

*The ‘cash’ market in a security is that segment of trading in which the security is bought outright or sold outright. The term is used to distinguish outright buying and selling from repo trading in the same security.

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