Have hedge funds increased their use of repo borrowing?

The purpose of Bank Overground is to share our internal analysis. Each bite-sized post summarises a piece of analysis that supported a policy or operational decision.
Published on 07 February 2020

Our survey data show that hedge funds used repo markets to borrow more in 2019. Hedge funds can use repo to increase their leverage, which magnifies their potential gains and potential losses. Demand for funding by hedge funds may have been one of the factors related to increased volatility in the US dollar repo market last year.

Sale and repurchase agreements, also known as repos, are transactions that involve a security (usually a government bond) being borrowed on a short-term basis in return for cash. Repos play a key role in the financial system.

The repo market is used by dealers to earn a return on their securities and by banks to earn a return on their liquid assets.

Hedge funds use the repo market both to borrow cash, by placing securities as collateral with dealers, and to borrow securities from dealers, offering cash in return. Hedge funds can use repo to increase their leverage, which magnifies both their potential gains and their potential losses.

Market intelligence, as well as our survey data, provide evidence that hedge funds significantly increased their reliance on short-term funding via repo in 2019. Chart A shows the value of cash that prime brokers lent to and borrowed from hedge funds over the past few years.

Between October 2018 and April 2019, there was a 41% increase in the amount of cash borrowed by hedge funds through repo. This fell slightly between April and October 2019, but was still up 20% year on year between 2018 and 2019.

Market intelligence suggests this was at least partly because certain types of hedge fund borrowed more money to take advantage of price differences between US treasury bonds and bond futures.

This demand for funding from hedge funds may have been one of the factors related to increased volatility in the US dollar repo market in 2019.

Chart A Hedge funds increased their cash borrowing via repo in 2019

Cash value of prime brokers’ repo and reverse repo lending to hedge fund counterparties (a)

Sources: Bank of England Hedge Fund as Counterparty Survey and Bank calculations.

(a) Data are from a biannual survey conducted by the Bank of England, which captures data on hedge funds via their prime brokers.

This post has been prepared with the help of Thomas Baines and Matt Roberts-Sklar.

This analysis was presented to the Financial Policy Committee in December 2019.

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