'Fail' in Repo Market, Pay a Price

Participants in Treasury Securities Repurchase Face a Fee if They Can't Deliver By DEBORAH LYNN BLUMBERG The $5 trillion Treasury securities repurchase market, crucial to the smooth functioning of the financial system, gets a makeover on Friday: Participants will be charged a fee when transactions "fail." The Treasury repo market is where dealers and companies lend Treasury securities to one another in exchange for cash loans. The Treasury Market Practices Group, an industry body sponsored by the Federal Reserve Bank of New York, has suggested investors who fail to deliver borrowed Treasurys on time pay a three-percentage-point fee. The guidelines, aimed at increasing the market's efficiency, follow severe market disruptions last year, when repo failures spiked to more than $2.7 trillion in October. Many investors were unwilling or unable to return the securities borrowed amid the general market panic caused by the bankruptcy of Lehman Brothers. The hope is that the charge will discourage failures and make Treasury repo transactions much smoother. A better-working repo market also could aid the stabilization of financial markets and the healing of the broader economy. "Anything that promotes efficiency in the Treasury market ultimately results in lower interest rates, which can't hurt the economic outlook," said Joseph Abate, a money-market strategist at Barclays Capital in New York. The fee is expected to result in repo rates going negative, with demand increasing for very scarce Treasury issues as investors search with more gusto for the Treasury securities they must deliver to avoid the fee. Negative repo rates mean investors extending a cash loan are paying for the privilege of owning a Treasury note. Some notes, including the two-year and five-year notes, already have been trading at negative rates off and on over the past two weeks. As Friday approaches, some analysts are concerned that repo rates could turn even more negative, which could hurt the broader Treasurys market. Mr. Abate, for one, said those concerns are overblown. He expects the market to become more segmented once the fee takes effect. Issues that are already scarce, about 5% to 10% of the market, should trade at very negative levels, possibly below a negative 1%. The rates for less-scarce issues are likely to be well below the general collateral rate, but not deeply negative. One reason is the huge amount of Treasury debt the government is to sell this year, which should alleviate scarcity in the repo market. But others worry that the charge will make it more expensive for investors to bet against securities and could possibly affect how investors bid at Treasury auctions, leading to higher interest costs for the government. Write to Deborah Lynn Blumberg at deborah.blumberg@dowjones.com