REPO transactions have been used on the territory of the Russian Federation not so long ago, and therefore Western was taken as a model of work. The rapid development of such relations between the borrower and the lender became possible due to the fact that operations with securities, that is, stocks, are gaining more and more popularity. In English, a repurchase agreement sounds like a repurchase agreement (translated as “buyback agreement”), abbreviated as repo.
What is a repo transaction?
REPO transactions are trading operations that are carried out using not only a certain currency and capital, but also with securities. In addition, such arrangements mean that the parties enter into an agreement on the repurchase of securities. This can be explained more simply with a small example.
Party A sells its securities to party B for a certain amount, which is considered a loan. The sale is carried out through a regular sale and purchase transaction. However, in addition to this agreement, one more is concluded, which necessarily stipulates the period when the borrower agrees to redeem his securities back. In the same agreement, the parties immediately determine the price at which shares will be repurchased. It will be impossible to change the redemption value after the conclusion of the agreement. It should be noted that if other exchange operations are much more difficult to carry out, then repo transactions at the bank can be carried out by any person who holds a block of shares.
Types of repos
There are three types of repurchase agreements. The difference is made according to the timing of the agreement.
- The first type was called "overnight", that is, the duration of such an agreement is one day.
- Derivative repos are agreements that provide for a specific maturity of a debt. Such a period should be more than one day.
- The latter type is called "open". Such agreements do not have a pre-established day on which it is necessary to return the money.
There are two parts to repos. The first part is the receipt of cash for shares, and the second part is the repurchase of securities back. It is worth saying that any agreement has its term, regardless of what type of transaction was concluded. This period is calculated in calendar days and starts its account from the day following the conclusion of the first part of the agreement and is valid until the day when the second part of the agreement is inclusive.
Types of repos by maturity
REPO transactions are also divided into several types according to the terms of execution of the agreement.
- The first variation of the described agreement is called intraday or one-day. In this case, both the first part of the transaction and the second must be completed in one day. The deadline for such an agreement is one day.
- The second variety is existing deals. This means that the first part of the agreement has been executed, and the deadline for the implementation of the second part is already underway.
- The last type is open trades. The conclusion of such an agreement suggests that the period between the completion of the first part and the second has no established boundaries.
Depending on the contract concluded, the interest rate for the second part of the contract will also be determined by the timing. When concluding a one-day transaction, the rate remains fixed, with an open transaction the rate will be non-fixed, that is, floating, and with an urgent agreement, the rate will remain at the same level throughout the term, that is, it will also be fixed.
Off-exchange repurchase agreement
Securities repos are not only a fairly common instrument for trading on exchanges, but also a very popular investment program. The thing is that the conclusion of such agreements is beneficial for both parties to this agreement. It is also very important to note that the conclusion of such a transaction between the parties is not a loan as such. Such a trade is considered to be the conclusion of a normal sale and purchase agreement. Although in banking practice they successfully carry out lending through securities. To conclude such agreements, a special normative act was developed in the state bodies of the Russian Federation, which is designed to regulate the entire resale process.
Repo Types
It is worth noting that the practice of applying such trade agreements is used on the territory of the Russian Federation, taking into account all examples of Western countries. This mechanism is necessary because it allows you to conclude quick and effective transactions in the capital market. Without using this tool, many different problems can appear.
There are two types of repos that are used in different conditions. The first includes the conclusion of the most typical and widespread trade transaction, which in the first part carries information about the purchase amount and terms, and the second part contains the terms of the buyback, the rate and the total amount.
In addition to such typical agreements, reverse repos are available. This mechanism found its application in exchange trading. The essence of the contract is concluded in the name itself. With this type of agreement, you must first agree on a sale, and in the second part, on a repurchase. It is worth noting that one-day repo transactions also found their application. They are widely used on bid day or at auctions.
Contract and accounting for repurchase agreements
There is a law that stipulates that all transactions falling under the category of REPO must be executed in writing. When drafting a standard model contract, it should include several of the following items:
- names of persons who are direct participants in the contract;
- description of the subject of the agreement. That is, the deadlines are stipulated, and it is also indicated that the first part and the second should have different dates for their implementation;
- a description of the actions that will be taken when purchasing securities, as well as their quantity, their value, their nature;
- description of the procedure for accounting on a depo account;
- reverse sale, during the process of which the terms, rate and total amount of the transaction are agreed;
- possible risks and types of compensation;
- details of each side.
It is also worth adding that all holders or owners of any financial assets are required to keep their records. To do this, open a depot account. This must be done, as this account is taken into account when taxing a private or legal entity.
Benefits of REPO Transactions
The conclusion of such trade agreements has some definite advantages. The main advantage that distinguishes repos from a regular loan is that when a transaction is concluded, the creditor (that is, the buyer of securities) will not be a pledge holder, but a full holder of the block of shares that he acquired. For this reason, failure to execute a repo transaction is not so risky for the lender. Indeed, in this case, he has every right to simply sell this block of shares at its market price. And you do not even need to coordinate this action with the debtor.
On the part of the borrower, the benefits are expressed in that the rate will be lower. This is due to the fact that the lender does not conduct solvency assessments and other operations of his borrower. In addition, it is possible to enter into a repo transaction even if the bank traditionally refused to receive a loan because of a short credit history, for example.
Disadvantages of REPO Transactions
It is worth noting that situations may arise where the advantages of a repurchase transaction may become disadvantages. Most often this happens if at the conclusion of the contract penalties for refusing to fulfill obligations were not drawn up and confirmed.
A situation may arise when, for example, at the time of the buyback, the shares became much more expensive, it would be more profitable for their lender to sell them on the market than return them to the borrower. The disadvantage for the borrower is that during the sale of these securities they fell quite strongly in value, and buying them back is too unprofitable.
Taxes
It is also worth noting that all the results of transactions such as repos are taxed. In addition, separate taxation conditions were prescribed for them. However, this applies only to those agreements in which securities will appear. And you also need to add that the law spells out a period that should not be exceeded when concluding a REPO. This period is six months. In addition, special taxation conditions cannot be applied if the second part of the repo agreement has not been executed. In such cases, the general tax conditions are used to fulfill the first part.