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25. What happens if a party fails to deliver collateral in a repo?
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There are two occasions when this might happen: at the start of a repo, the seller may fail to deliver to the buyer; or at the end of a repo, the buyer may fail to deliver to the seller.

In the event of a failure by a seller to deliver collateral securities to the buyer at the start of a repo, if the parties have signed the ICMA’s Global Master Repurchase Agreement (GMRA), one of the following will happen:
  • If the parties have agreed, when they negotiated their agreement, to treat a failure to deliver collateral securities as an event of default, the buyer could place the seller in default. However, putting a counterparty into default is a very serious step. Before doing so, it is important to be sure that the seller’s failure to deliver reflects credit problems and not temporary operational problems, infrastructure frictions or market illiquidity, which can be beyond the seller’s control.
  • The contract remains in force, allowing the seller to deliver the collateral securities at any time during the remaining life of the contract. Only if and when delivery eventually takes places will the buyer pay the seller. But at any time while the failure to deliver continues, the buyer can terminate the contract and the seller will be contractually obliged to pay the repo interest accrued up to that point. In other words, the seller will have to pay repo interest even though he will not have had the use of the buyer’s cash. This means that the seller is charged for failing to deliver and the buyer is recompensed.
In the event of a failure by the buyer to deliver collateral securities to the seller at the end of a repo, if the parties have signed a GMRA, one of the following will happen:
  • If the parties have agreed, when they negotiated their agreement, to treat a failure to deliver collateral securities as an event of default, the seller could place the buyer in default. As for a fail on the purchase date, before placing a counterparty into default for failing to deliver, it is important to be sure that the buyer’s failure to deliver reflects credit problems and not temporary operational problems, infrastructure frictions or market illiquidity, which are all beyond the buyer’s control.
  • The seller could call a mini close-out, which is a colloquial term for the right of the buyer to terminate the failed transaction (but no others), value the collateral in that transaction using the methodology set out in the GMRA for defaults (see question 26), offset this against the cash he owes the buyer and settle any difference. However, mini close-outs can prove to be very expensive for parties failing to deliver. In repo markets, such as those for government bonds, which trade at narrow spreads, the risk/return ratio is so skewed that it is felt that the threat of mini close-outs would drive many banks out of the market and fatally damage its liquidity, so mini close-outs are in practice restricted to fails in types of collateral such as corporate bonds. Note that the mini close-out mechanism works differently from the buy-in procedure used in the cash market when the seller fails to deliver to the buyer in an outright transaction (in this case, the security is bought from the market and any extra cost is passed to the failing party).
  • The parties could negotiate a solution. Until then, the repo would continue, with the seller holding cash, which will be interest-free after the repurchase date, thus recompensing the seller and charging the buyer.
In the event of a failure by the seller to deliver collateral securities at the start of a repo or by the buyer to deliver at the end, if the other party has paid cash to the failing counterparty before discovering that there has been a failure to deliver, he can require the failing counterparty to immediately repay the cash or he can make a cash margin call to recover his cash. If the failing counterparty does not promptly return the cash, he risks being placed into default. In practice, however, cash will rarely be paid without delivery given the prevalence of settlement by delivery-versus-payment (DvP).


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