Given the amount of information required to demonstrate the complete flows of a repo trade, the graphic is tough to navigate without a PDF version. Subsequently, we’re providing one for all readers below.

Conks Infographic The Modern Repo Market

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Still, even with complete visuals, a written explanation is needed to comprehend such an intricate ecosystem. Welcome to a Repo 101: a brief primer that will complement Part II of our current target rate series, covering repo lingo and mechanics in plain English. This is not the usual Conks style of article. Instead, it’s written to clarify all key repo fundamentals and rates as concisely as possible.

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The latest phase in the fortification of the U.S. Treasury market has achieved even greater levels of pandemonium. Monetary leaders continue to fret over illiquidity, hallmarked by the U.S. Treasury initiating Operation “Delay Duration”, potentially suspending an expansion in long-end issuance until 20271. The latest boost in UST (U.S. Treasury) buybacks will also further stem volatility, neutralizing congested dealer inventories. POTUS, meanwhile, has backtracked on unseating Powell as the central bank chairman after threats to the Fed’s independence dramatically steepened the curve. This occurred just as central bank officials revealed that the Fed’s Relief Valve could include exempting USTs at the dealer level2, providing (supposedly) an extra boost to the plumbing. But while “illiquidity hysteria” continues to capture public attention, private players have been driving a quiet liquidity revolution, one that has bolstered the UST pipes in the most restrictive regulatory climate on record.

Financial alchemy has reached new extremes. Traditional cash markets, including the secondary U.S. Treasury market3, are now competing with the rise of a new “bond-like” ecosystem still in its early stages of expansion. The post-GFC battle for market-making dominance between top liquidity providers, both traditional and emerging, now involves conquering a rising shadow arena. Much like the shadow banking system and the interplay between banks and shadow banks, the “cash market” has gained a counterpart: the “shadow cash market,” which participants turn to when liquidity can no longer be tapped via traditional flows impeded by post-crisis regulations4.

With fresh market mechanisms, however, come new dangers. Shadow cash trades will expose another inconvenient truth for monetary leaders attempting to prevent further intervention by reinforcing the UST market’s inner workings: in times of crisis, other barriers not enforced or produced via regulation will continue to impede the major market players.

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The mammoth endeavor to strengthen the U.S. Treasury cash market1 has entered a new iteration. In the face of immense supply, ever-increasing measures to fortify the most systemically important debt market have now been paired with a new admin’s desire to greatly suppress yields on U.S. Treasuries (USTs). Monetary heads of state have hinted at enabling greater incentives2 for the largest market makers to absorb incoming issuance, potentially boosting the balance sheet capacity of dealers enough to initiate a “plumbing liberation”3. Officials are now in a semi-race against time to toughen the pipes of the UST plumbing before the next market episode arises.

The fortification of the U.S. Treasury market is now fully underway. While Sec Bessent and POTUS execute policies (aiming) to dampen yields, thought leaders both inside and outside the Federal Reserve have expanded their efforts to instill confidence in America’s sovereign debt goliath. The release of regular, optimistic liquidity checkups, plus the removal of obstacles preventing hedge funds from arbitraging dislocations, are just a few examples. Elsewhere, under the all-seeing eye of the agencies4, the FICC (Fixed Income Clearing Corporation) — the sole central counterparty for USTs — has begun to liberalize access to its centrally cleared markets, an ecosystem believed to quash systemic risk. As leaders enforce relentless measures to bolster market stability, however, obscure regions of financial markets, unknown to most, continue to provide a substantial liquidity boost.

Over the past few decades, financial alchemy created by major liquidity providers, both traditional (i.e. banks with primary dealer arms) and contemporary (other non-bank market makers5), has been largely concealed from the mainstream while giving rise to fresh techniques that grease cash bond liquidity. Dealer banks and other “legacy” market players have somewhat retreated, leaving nascent market makers to fill in the liquidity gap6. The Shadow Cash Market, where “bond-like” exposures allow market makers to intermediate trillions of dollars in fixed-income securities, has thus arisen. Liquidity in the most systemic market is consequently being underestimated, but also a subsequent batch of constraints that could bite major players during the next UST market upheaval.

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At the end of December 2023, the Federal Reserve’s RRP (reverse repo) facility — the U.S. central bank’s “shock absorber” for excess dollars unable to be invested elsewhere — continued to drain. Plunging toward zero, the Fed’s facility had shed trillions in surplus cash now fleeing to higher-yielding assets such as t-bills, flows that would soon alter the dynamics in repo markets. The enormous overload of money that had poured into repo markets via the Fed’s COVID-19 liquidity injections was about to dry up, prompting market participants to begin to trade primarily among themselves. Instead of rates remaining pinned to the overnight rate the Fed paid on its RRPs — dubbed O/N1 RRP, private sector entities would start to determine where most repo rates printed. The total “unzombification” of repo markets was fast approaching.

Suddenly, however, on December 29th, 2023, the multi-trillion-dollar descent in the level of Fed RRPs was halted temporarily by a ~$200 billion rise in volume. Repo rates simultaneously began to skyrocket, with the cost to borrow cash in the interdealer (GCF) and dealer-to-customer (DVP) markets — ultimately financing the elaborate trades of hedge funds and others — rising sharply. The cause? Yet another “quarter-end”: the last day of each quarter on the financial calendar and the most likely to encounter volatility. As with most quarter-end (but especially year-end2) dates, the prominent repo dealers were pulling back severely from market-making in the most crucial dollar funding ecosystem. The trading desks of the major broker-dealers and dealer subsidiaries of the largest banks (BHCs) — all operating as primary dealers — delayed their duties to unwind or rearrange trades linked to the most infamous regulatory exploit in the modern era.

For a decade or so, via one method or another, the banking giants have bypassed numerous constraints proposed by the Basel III Accords, a sea of regulations introduced after the GFC to limit excessive bank risk-taking “once and for all.” In what’s known as “window-dressing,” some dealers (primarily foreign dealers) have yet to be required to declare their regulatory metrics using daily averages, the absence of which has allowed them to expand their balance sheets over lengthy periods in which they don’t need to reveal costly or uncompliant exposures to regulators. Before the deadline to disclose their activities, banks have quickly unwound their soon-to-be illicit trades.

Rather than serving as fully active market makers on “period-end” dates, such as quarter-ends and year-ends, dealers have been rewiring their balance sheets to appear as if they took much less risk during certain timeframes than in practice. Consequently, on and around crucial reporting periods, banks’ window-dressing has created temporary “air pockets” of illiquidity (even turmoil) in repo markets. Because most repos3 — short-term cash loans secured against collateral — can be rolled over forever but unwound swiftly the next day, these are the first assets to be dumped by banks whenever they hold excess exposures and reporting dates grow near. Liquidity in repo markets thus grows scarce. Rates must adjust higher to attract those willing to make markets with limited balance sheets, ultimately provoking infamous rate spikes.

At the end of December 2023, the largest repo liquidity providers were either reducing or reshuffling their balance sheets to report more favorable metrics, inducing one of the most bizarre yet typical scenarios in money markets. With regulatory limits now compulsory, banks with available but inflexible balance sheets stepped in by lending cash to dealers and other market participants at hefty spreads. Rates even surpassed what the Fed offered via its Standing Repo Facility (SRF), a mechanism that supposedly enforced an upper limit on repo rates. Since the SRF was set to open (as usual) at 1:30pm — long after the peak repo trading hours of 8-10am, dealers were forced to secure dollars via private markets at rates above the Fed’s repo “ceiling.” Meanwhile, with their usual dealer counterparties unwilling to provide liquidity, money market funds (MMFs) — the major cash investors in repo markets — were forced to accept a lower return on their cash by parking it at the Fed’s RRP facility.

Although somewhat defective, the Fed’s tools for enforcing upper and lower limits in its repo hierarchy were able to stem a full-blown liquidity squeeze in both directions — the RRP providing a (soft) rates floor and the SRF providing a (soft) rates ceiling.

Fast forward to today, and repo market participants have witnessed countless further rate spikes on key financial dates. Only last month, SOFR (the Secured Overnight Financing Rate), the Fed’s primary measure of repo rates, rose again to recent heights, causing a stir in the media. With increased money market unrest, regulators appear to have witnessed enough to want to finally avert most, if not all, banks from evading Basel III and provoking market disruptions. The global regulatory complex, following the usual lengthy pause, has reached its near-maximum tolerance for allowing the most observable regulatory arbitrage in dollar funding markets to continue unabated. Officials have commenced a slow purge of the most significant incentives, attempting a Great Flattening of repo rate volatility. Yet, this flattener may prove more difficult than they expect. Catalysts other than the Basel III Accords will continue to spur instability. Let’s dive deeper into the plumbing.

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The multi-trillion-dollar repo market remains the most elaborate financial ecosystem on the planet. Unlike most regions of the global financial system, which are well observed and understood, the market for repos — short-term cash loans secured against securities as collateral — has stayed obscure. So much so that the least transparent region has grown to become the largest and most influential: the dealer-to-customer market. Here, dealers provide repos (temporary swaps of securities for cash) and reverse repos (temporary swaps of cash for securities), which they fund by borrowing cash in the triparty market, repo’s “dealer funding” market, and trading in the interdealer markets, where dealers trade repos (again, swapping cash and securities temporarily) among themselves.

The end goal of repos traded outside the dealer-to-customer market is to ultimately finance repos inside the dealer-to-customer segment, the plumbing of which is specially designed for dealers to facilitate trading activities of their true “customers”: hedge funds and other speculative players — such as REITs, banks, and insurance companies — engaging in leveraged bets on (mostly government-issued) financial assets, primarily U.S. Treasuries. Somewhat unintentionally, these speculative trades create more liquid, thus more efficient sovereign debt markets, helping to power America’s financial hegemony.

Enabling trillions in speculative trading volumes daily is the defining feature of the dealer-to-customer market: how securities pledged in repos as collateral are “settled” — i.e. transferred between participants. Dealer-to-customer repos remain the only type of repo that enables the transfer of securities between participants’ accounts during trades — unlike other repo markets that merely record the securities as pledged on relevant trading systems. These direct securities transfers allow the repo participant who’s lending cash and receiving securities as insurance to trade this “collateral” (another name for the securities received) in the secondary markets — like the Treasury cash market, before returning them (or other identical securities) to exit repo trades. Hedge funds, for instance, will enter a leveraged long position (far exceeding their available cash on hand) in a U.S. Treasury security by buying one in the secondary Treasury market and enabling this purchase by borrowing cash in a repo. It will then post the security as collateral to the dealer in the same repo used to raise cash for its initial Treasury purchase. To exit the trade, the hedge fund simply sells the Treasury security and uses the cash proceeds to repay (and thus close) the repo it used to enter its leveraged long position.

Only the plumbing of the dealer-to-customer repo market, however, enables such trading. Hedge funds must obtain and deliver securities via their official securities accounts, not only to repo dealers but to buyers and sellers of U.S. Treasuries in the secondary market. For this to happen, these assets move between participants’ official securities accounts housed on Fedwire, the Federal Reserve’s system for storing and transferring official “book-entry” (jargon for electronic) records of U.S. government securities, plus securities issued by U.S. government-sponsored enterprises — such as the agency bonds of Fannie Mae & Freddie Mac.

To enable optimal settlement of U.S. government securities trades, the Federal Reserve employs a mechanism known as “DVP”, short for “delivery versus payment”. In what’s known as DVP settlement, the delivery of securities and the associated cash payment must only be settled simultaneously. When either the required funds or securities are missing from participants’ accounts, Fedwire will consequently fail to process both sides of the transaction. Thus, “delivery” occurs only “versus payment.” Because all dealer-to-customer repo trades settle via Fedwire’s DVP mechanism, the dealer-to-customer repo market is also commonly called the “DVP repo market” or “DVP repo” for short. DVP repos are thereby another term for dealer-to-customer repos, with the “customer” in “dealer-to-customer” (thus DVP repos) consisting of sophisticated players looking to speculate and engage in leveraged trading, not risk-averse cash investors such as money market funds (MMFs), which aim solely to earn interest from investing cash — using securities pledged to them in repos as insurance for their cash lending, not for deploying into elaborate trading strategies.

Despite all of its transactions settling via Fedwire’s DVP mechanism, the dealer-to-customer repo market has been split in two, divided by whether or not cash and securities also pass through the accounts of the FICC (Fixed Income Clearing Corporation), the lone central counterparty (CCP) that provides centrally cleared repo trades. Upon repo participants sending cash and securities (as margin) to its “clearing fund” — essentially a collective pot of money, the FICC guarantees settlement of cash and securities swapped in DVP repos by intervening when necessary via the Fedwire system. CCPs like the FICC will use cash accumulated in their clearing funds to offset a participant’s losses from a counterparty default, dispatching cash or securities to the affected accounts. Trades employing the FICC’s safeguards are known as centrally cleared repos — and sometimes as “cleared repos,” shortened for simplicity, not clarity, as every repo trade goes through clearing (i.e. the process of arranging settlement). For cleared repos settling via Fedwire’s DVP mechanism1, parties submit trades to the FICC’s DVP Service, in which the FICC organizes cash and securities traded in a DVP repo to be transferred via Fedwire while also guaranteeing settlement. Though the FICC’s DVP service has been classed officially as an interdealer market, it’s turned into a dealer-to-customer market, with dealers mainly intermediating cash from MMFs to hedge funds.

Meanwhile, the market for DVP repos that settle outside the FICC, i.e. directly between participants’ accounts over Fedwire, has been assigned the unfortunate name of “non-centrally cleared bilateral repo” or NCCBR. Its convoluted name derives from how trades aren’t centrally cleared by a CCP, hence “non-centrally cleared” or sometimes “uncleared” — again, shortened for simplicity, not clarity, as all repo trades are cleared in some capacity. “Bilateral” describes how NCCBR trades settle on a “bilateral basis”, jargon for how securities aren’t custodied by a third party during the repo and instead move directly between participants’ securities accounts. Whether centrally cleared or not, all DVP repos settle bilaterally. Accordingly, a “bilateral repo” is (yet another) term to describe DVP repos (thus dealer-to-customer repos). Not confusing at all.

Together with the FICC’s DVP Service, the NCCBR market forms a liquid ecosystem for dealer-to-customer repos, a repo market for leveraged speculators that tops $5 trillion in daily volumes.

To facilitate the world’s sizeable thirst for leveraged trading in U.S. government securities, dealers partake in an endless game of “repo hot potato,” swapping securities for cash via repos and cash for securities via reverse repos and charging a fee for providing liquidity. This game occurs not only in dealer-to-customer markets but in every other repo segment. In the most common chain, an MMF will lend dollars short-term to a dealer in triparty, the dealer funding market, swapping dollars for securities. The dealer will then swap dollars for securities with another dealer or a speculative customer in the other repo markets and use the collateral received to back its initial dollar borrowing — or finance another chain of repo transactions. The MMFs earn a secure return on investors’ cash, while dealers provide speculators with the ample liquidity they desire. For the Fed’s primary dealers, now providing the vast majority of repo liquidity, this game of hot potato never ends. After streamlining trillions of dollars in repos every day, primary dealers’ repo chains have grown immensely.

Yet most of these chains have also expanded in the shadows, specifically within the uncleared — thereby opaque — region of the dealer-to-customer repo market, where the most sophisticated game of repo hot potato ensues. To demystify this contest, plus uncover the intricacies of the most elaborate part of the financial system, let’s take an extensive dive into the plumbing of NCCBR: non-centrally cleared bilateral repo.

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Despite evolving into the most crucial dollar funding mechanism, the U.S. repo (repurchase agreements) market has remained relatively obscure. In just the triparty segment (covered in Part I) alone, trillions of dollars change hands daily with little transparency. Behind the scenes, the Fed’s primary dealers raise dollars from global cash investors to enable the speculative activities of numerous financial players, from highly leveraged hedge funds to Wall Street behemoths. Still, triparty only scratches the surface of the repo colossus, acting merely as a funding layer for numerous other markets, each more elaborate and specific in its purpose than its closest counterpart.

Next in this hierarchy lies the interdealer (dealer-to-dealer) market, known officially as GCF repo, where traders on dealer desks battle among themselves to earn the juiciest market-making spreads while providing liquidity to the wider repo ecosystem.

In this subscriber special, we’ll demystify the inner workings of the interdealer market, unveiling in detail through visuals and plain English (wherever possible) how GCF repos help to form the most influential chains in global finance. Let’s dive in.

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That is, however, until now. In this comprehensive deep dive, we’ll demystify the inner workings of the U.S. Treasury market, both past and present, unveiling the history, mechanics, and monetary plumbing of the most systemically important market globally. Let’s dive in.

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In this comprehensive subscriber special, we’ll demystify the seemingly intricate triparty repo market — the “base layer” of repo — unveiling in detail its origins, daily cycle, monetary plumbing, and flows, all mapped out using our trademark visuals. Let’s dive in.

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In the late 1960s, a group of Wall Street megabanks set out to build the Asian dollar market. Rapid economic growth and greater participation of multinational corporations in Asia prompted major foreign currency flows into the region, most of which (as usual) were U.S. dollars. Taking advantage of Singapore’s lenient laws after its recent independence, executives from Bank of America negotiated a deal with Singaporean leaders, granting the U.S. megabank the power to borrow and lend offshore dollars cheaply and efficiently. The “Asian dollar market”, a bare-bones replica of the parallel Eurodollar market, was about to materialize.

At the time, Tokyo and Hong Kong had grown into the major international banking centers of Asia. Yet Singapore became Wall Street’s choice as a pipeline to funnel in dollars from the West. The Japanese, despite creating the most advanced banking system, had discouraged offshore dollar business via strict exchange rate controls. Meanwhile, Hong Kong had prevented itself from becoming a dollar banking center by imposing a 15% transaction tax on interest paid to foreigners. Instead, looking for the most attractive Asia-Pacific hub, U.S. banking giants found Singapore’s increasing urge to deregulate finance as the dealmaker. From eliminating stamp duties to reducing taxes to lowering banks’ reserve requirements, the Singapore elite gave Wall Street and the rest of global finance a clear message: The small island nation was desperate to become Asia’s major dollar center.

As the 1970s passed, many other financial behemoths active in global dollar markets obtained full or partial banking licenses from the MAS (Monetary Authority of Singapore). In exchange for accepting the costs of potential liquidity crises, officials allowed over fifty banks — with headquarters ranging from Tokyo to New York — to set up Asian Currency Units (ACUs): independent bank branches that engaged mainly in offshore currency transactions, recorded on a separate set of books. These “ACU banks” combined to form a leaner version of the Eurodollar system, where banks raised unsecured dollars outside the U.S. (by convincing depositors to place their funds in overseas branches), lent out these dollars and profited from the spread.

The offshore dollar market had thus evolved into two parts: the Eurodollar market and the Asian dollar market, identical in functionality but different in accessibility and location. Most available via London banks (so-called Eurobanks) but also Asian dollar bank branches (ACUs), U.S. dollars were then channeled to other international banking centers in need of funding. Acting as dollar plumbers, globally active banks borrowed money over short periods and lent it out over longer periods, in what’s called “maturity transformation”. The interest rate to borrow Eurodollars short-term was cheaper in some markets than the rate earned from lending in others over longer periods. The larger the spread between borrowing and lending, the greater the profit. Dollar plumbers were therefore consistently on the lookout for the widest spread possible, which usually arose from engaging in “regulatory arbitrage”: exploiting loopholes closest to the boundaries of legality for the highest returns. Coincidentally, Eurodollar transactions in the Asian dollar market were some of the most lucrative.

Compared to today’s eurodollar markets, the Asian dollar market in the 20th century was a thriving marketplace. The GFC (Great Financial Crisis) in 2008, however, prompted the global regulatory establishment to declare war on unsecured lending, not only in Europe but also in Asia. Let’s explore the evolution and subsequent devolution of the most arcane money market globally: the Asian Eurodollar system.

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Since the Great Financial Crisis (GFC) of 2008, the Federal Reserve has operated a system, not built on sound pre-planning, but on its responses to a seemingly endless number of crises in increasingly complex markets. Its decision to flood the financial system with bank reserves shattered the existing mechanism for setting interest rates, sending Fed officials on a journey to implement a fresh monetary regime: The price of money (interest rates) would no longer be set by the Fed altering the number of reserves in the system but by implementing a set of rates. The result? The gradual emergence of the Fed’s “global jaws”.

First came the Fed’s initial upper jaw in 2008. On October 6th, shortly after the fall of Lehman Brothers, the Fed started paying interest on reserve account balances, most of which belonged to the big Wall Street banks. Named IORB or “interest on reserve balances”, this rate acted as an anchor on Fed Funds, holding it — and other short-term money market rates — within the Fed’s newly established target range (as seen below in navy blue).

Though a significant change, paying interest on bank reserves was just the start of the Fed’s jaw construction. Soon after, officials began assembling a soft lower jaw: a tool to nudge falling money market rates, including Fed Funds (EFFR) and short-term Treasury yields, back into its target range. In late 2013, with both rates and yields near zero and approaching negative territory, Fed officials grew worried, not only about yields on Treasuries turning negative, but that when the Fed hiked for the first time since the GFC, raising the IORB rate (the Fed’s upper jaw) was sufficient to drive short-term rates higher. The Fed reacted swiftly, implementing an overnight reverse repo facility, commonly known as the RRP. This allowed certain banks, money market funds, and GSEs (government-sponsored enterprises, like Fannie Mae and Freddie Mac) to lend to the Fed at its overnight repo rate (ON RRP). By increasing ON RRP, the Fed could raise short-term rates whenever it deemed necessary. Its soft lower jaw was now in operation.

The initial versions of the Fed’s upper and lower jaws, however, were defective and incomplete. Still to surface were various disruptive episodes, which would come to remold their initial structures. After the infamous “repocalypse” of September 2019, the Fed introduced the standing repo facility (SRF), setting a hard ceiling on repo rates. Entities borrowed cash at the standing repo rate (SRFR), bypassing higher private borrowing costs, which restored balance in markets. A few years later, the COVID market meltdown showed that the Fed required a permanent global backstop. Monetary leaders reintroduced official central bank swap lines, fortifying the Fed’s upper jaws. Still, the Fed’s job wasn’t done.

The volatility of COVID-19 was so extreme that it threatened the stability of public institutions’ dollar portfolios. Struggling with a volatile atmosphere, foreign official institutions (FOIs) — namely the treasuries and central banks of foreign governments plus international organizations — were on the brink of firesaling U.S. Treasuries and other dollar assets to raise cold, hard cash. Before a governmental-level calamity ensued, the Fed stepped in, adding another layer to its global jaws. The FIMA repo facility, the Fed’s “final frontier”, was born.

Alongside the private dollar ceiling of swap lines, a public dollar ceiling was about to provide America’s allies and rivals with another safety mechanism in times of crisis. Yet it would also increase the world’s reliance on the U.S. dollar and its many derivatives. What did this look like in practice? Let’s go deeper into the mechanics.

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Back in 2019, before the Fed unleashed trillions of dollars in liquidity to stem COVID fears, global markets had entered a lengthy “excess collateral” era. The Fed’s RRP (reverse repo) facility, a shock absorber for excess cash and the defacto measure of surplus liquidity, lay empty. Almost every dollar was being deployed by private sector entities into trades that did not alter the Fed’s balance sheet, from repos funding leveraged Treasury investors to Eurodollar arbitrage by New York branches of foreign banks. Soon, however, a relatively unknown trade was not only about to upend the excess collateral era but also the illusion of financial stability in the Fed’s post-crisis system.

Midway through September 2019 on the 17th, a funding squeeze caused money market rates to skyrocket. The Fed’s SOFR (Secured Overnight Financing Rate), a measure of the average cost to borrow cash secured against U.S. Treasuries, showed repo rates spiking above a whopping 5%. Meanwhile, in a frantic search for other sources of dollar funding, financial entities had even begun tapping the once-lifeless interbank funding market, sending the Fed Funds rate (EFFR) above the U.S. central bank’s upper limit of its target range.

The Fed responded with a Standing Repo Facility, and shortly after, the “repocalypse” subsided. But the central bank’s bottomless interventions were no longer the major astonishment. The system was not as stable as monetary leaders and prominent financial players had assumed. It was soon revealed that most market players knew on the day of the repocalypse that liquidity was about to grow scarcer than usual. Days before, most were aware that corporations would be pulling large sums of cash from MMFs (money market funds) to fund quarterly tax payments, while the U.S. Treasury would be issuing additional government securities into an increasingly illiquid market. Both would pull liquidity — in the form of reserves — from the banking system into the TGA, the government’s bank account housed inside the Federal Reserve System.

At the same time, those same financial actors had been assigning large quantities of reserves to trades in the repo market. While dealers increased their repo borrowing to a point where their inventories — and thus their balance sheets — had reached near capacity, lending in repo became so profitable that banks made more deploying reserves into repos than depositing these at the Fed and earning IOER (interest on excess reserves). These decisions were also made in the depths of the Fed’s first official QT (quantitative tightening) program, which aimed to drain billions in reserves from the financial system every month. All in all, the late-2019 repo market had become a ticking timebomb.

Yet in the aftermath and throughout the repocalypse, another market undergoing mild stress had barely been covered in the media: the $4 trillion-a-day FX swap market. As smaller participants failed to locate funding both in repo and the interbank markets, the rate to borrow dollars secured against foreign currencies spiked, though only slightly. But it was merely a few months after the repo spike faded from mainstream circles that we’d not only discover what real stress in the FX swap market looked like. The world would also come to acknowledge the Fed’s global dollar swap network as the FX swap market’s sole rescue mechanism in times of crisis. The Covid financial panic had emerged, and with it came swap lines.

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In early 2018, a string of events formed an exploit in America’s sovereign debt market. Following a large issuance of U.S. Treasuries, a fall in foreign demand, and regulatory reforms, asset managers — pension funds, mutual funds, and insurance companies — began to shift out of cash bonds and into long positions of their associated Treasury futures. This reallocation was so intense that prices of Treasury futures and of those in the underlying cash market began to diverge. Noticing this deviation and subsequent arbitrage opportunity, hedge funds increasingly took the opposite side of asset managers’ positions. The Treasury cash-futures “basis trade” was re-emerging.

By going “long the basis,” which meant simultaneously shorting Treasury futures and buying the securities underlying these contracts in the cash market, hedge funds — primarily relative-value funds — had high odds of profiting from what was deemed a nearly risk-free arbitrage. Futures prices kept rising markedly above the price of their underlying Treasury securities, allowing traders to buy bonds at a discount to what they’d receive when delivering these securities into futures contracts. The basis, the difference in price between cash and futures (minus financing costs), was the profit.

But although this trade offered nearly risk-free returns, the resulting profits were lackluster. For hedge funds to achieve significant enough returns, they had to employ immense amounts of leverage. To execute these highly leveraged trades, hedge funds called upon the bilateral repo market — the market for cash loans secured against specific securities. By borrowing cash against the Treasuries they would use to deliver into futures contracts, hedge funds only needed to commit a fraction of capital to finance basis trade positions. The amount of leverage hedge fund traders achieved was determined by the repo market they used to finance Treasury purchases.

Hedge funds borrowed in either uncleared, cleared, or sponsored bilateral repo markets, each dominated by leveraged players funding various exotic trades. While cleared and sponsored repo (which is the same as cleared but entities gain access to trading through a third-party sponsor) offered greater transparency and lower counterparty risk, uncleared repo markets delivered superior leverage. Cash lenders in each repo market lent money equal to the value of the Treasury securities the cash borrower (i.e. the hedge fund) pledged, minus a haircut: a percentage the lender subtracted from the security’s value to protect itself against adverse market movements. In the shadowy depths of the uncleared repo market, haircuts fell to as low as 0%, allowing for much higher leverage than cleared and sponsored repo markets.

Subsequently, uncleared bilateral repo — known officially as NCCBR (non-centrally-cleared bilateral repo) — swamped cleared repo in size and activity, with an extra ~$1.4 trillion in outstanding transactions. Soon enough by 2019, hedge funds were regularly borrowing up to a hundred times the capital they committed to Treasury basis trades, achieving in most cases more than 99:1 leverage. For every one dollar of capital, they borrowed a whopping $99 in repo to finance trades.

As 2020 approached, short futures positions had soared by over 100%, with hedge funds making up ~73% of the volume. Billions upon billions of dollars had been allocated to highly leveraged basis trades, on what was perceived to be a low-risk, high-return wager. The trade’s major vulnerabilities were only exposed to the fiercest of black swan events, but as it turned out, the COVID market panic was around the corner. Just as the basis trade was rippling into the mainstream, the Treasury Market Unwind™ had commenced.

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Ever since America disarmed financial tensions in the post-war period, virtually all prominent financial institutions from every major nation launched thriving dealer businesses. Not only that, but they assembled trading desks to make markets in just about every dollar funding instrument, from FX swaps to certificates of deposit (CDs) to repo agreements. Megabanks like JPMorgan even ran trading desks for lending and borrowing bank reserves, with brokers of Federal Funds (the official name for reserves traded in the Federal Reserve System) stationed in New York helping them source interbank loans and Eurodollars.

But with regulators, in response to the GFC (Great Financial Crisis) of 2008, implementing Conks’ Big Three™ — The Dodd-Frank Act (hindering banks’ risk-taking abilities), The Basel Framework (discouraging systemic risk and excessive leverage), and the SEC’s money market reform (substituting riskier dollar funding sources with safer alternatives), the “secured standard” has arisen.

Subsequently, most unsecured dollar markets have begun to decline into irrelevancy, along with the dealers and trading desks that fueled their ascent. As the secured standard has evolved and expanded over the past decade, most activity from its dying counterpart has been transferred over to repo (secured cash loans) and securities lending, which combine to form the Secured Dollar Funding Complex (SDFC). To understand the financial plumbing of the future, demystifying the dealers that supply liquidity to the SDFC is vital. Securities dealers, however, are quite intricate. It’s time to dive into the world of the monetary plumbers.

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The most common origin story of the Eurodollar is that, in the early post-war era, America’s adversaries needed a place to store dollars outside the U.S. banking system to avoid unexpected seizures. Another version is that around the same period, global financiers discovered a way to profit from regulatory arbitrage by lending U.S. dollars overseas. Both accounts are accurate, yet the Eurodollar could only emerge out of what Conks calls America’s post-WWII “global security pact”.

Following World War II, the U.S. by default became the dominant global superpower. But rather than choosing to conquer the world, the Americans instead convinced almost every major power to partake in a global “de-arming”: unobstructed trade on an international scale, with the U.S. providing the armed personnel to subdue (almost all) major conflict. This not only facilitated the most prosperous period in human history but the rise of the first truly global geopolitical currency.

Under America’s security pact, the financial giants of the world swiftly took advantage. The major U.S. banks set up branches not just in the U.K. — which grew to become the epicenter of Eurodollar activity — but worldwide. Major foreign banks then set up operations within the U.S., primarily in New York. This, combined with a prolonged period of heightened peace, not only gave rise to the most stable reserve currency on record. Financial behemoths had created the global dollar funding complex, featuring over 25 different types of dollar-denominated instruments, from FX swaps to reverse repos to commercial paper.

The global dollar funding complex helped spin intricate webs that provided dollars to anyone within America’s global security pact, but especially to those outside America’s borders. Introducing: the Eurodollar system.

The arbitrage above is one of many varieties of trades occurring in Eurodollar markets daily and reveals what “Eurodollars” have grown to become in the modern era of banking. But what exactly is occurring here? Let’s investigate.

A European bank (Deutsche Bank) is seeking to attract offshore dollar deposits solely to engage in arbitrage at its U.S. (onshore) branch in New York. In simple terms, Deutsche Bank is trying to profit from the rate between offshore dollars (dollar-denominated commercial paper in Europe) and onshore dollars (Federal Funds .i.e bank reserves).

Deutsche Bank issues CP (commercial paper) to an offshore prime money market fund, which pays the German bank using an offshore dollar deposit. The purchase of CP removes dollar deposits from the prime fund’s bank account at Barclays offshore branch and adds reserves to Deutsche Bank’s onshore master account at the Federal Reserve. Deutsche Bank then parks these reserves at the Fed for three months, earning 5.15% until its commercial paper expires. Upon expiration, the transaction is reversed. Deutsche Bank sends reserves back to Barclays, which then credits the prime fund’s offshore bank account with an equivalent dollar deposit. No borrowing or lending of reserves even occurs. It is the settlement of the dollar loan that causes the transfer of reserves, making the arbitrage trade possible.

By issuing offshore debt to dollar lenders, dollar borrowers (usually arbitrageurs) earn a profit on the reserves they acquire from the lender’s onshore bank, which settles the offshore dollar loan transaction. The dollar loan is booked offshore by removing a dollar deposit and replacing it with short-term debt instruments and is settled onshore with Federal Funds (bank reserves). The banks involved, Deutsche Bank and the prime fund’s bank (Barclays), clear the transaction offshore by updating their offshore banking records. Meanwhile onshore, Barclays sends Deutsche Bank the loan amount in onshore dollars (reserves). The German giant earns a profit on the spread between its offshore dollar funding costs (the rate it pays out on its commercial paper) and the rate the Fed pays on onshore dollars (reserves). In this instance, that is 5.15% (IORB or Interest On Reserve Balances) minus 5.05% (the rate on 3-month commercial paper), equalling a 0.10% return.

The way reserves are transferred in this trade is precisely the same as how payments settle between banks onshore (see below), but Eurodollar deposits clear in bank accounts offshore — or, in rare occasions, international banking facilities set up by the Fed.

The Eurodollar system, however, is much more than arbitrage trading. It’s a fully-functional banking system. Enabled by America’s global security pact, every major global bank is now plugged into almost every other country’s financial infrastructure. Most financial innovation that materialized inside the U.S. was swiftly replicated overseas, and vice versa. Soon enough, countries were not just using the Eurodollar system. They became part of it and helped build it out over multiple decades. Financial players in particular countries specialized in providing other nations with the dollar instruments they required, mostly without the U.S. authorities ever getting involved.

Since the Eurodollar system has been assembled by all the well-known financial institutions, offshore infrastructure is fairly similar. All the significant lenders and borrowers who participate in global dollar funding markets have longstanding relationships and operate entities that both borrow and lend dollars offshore. Prime money market funds, for example, have connections to all the big dealer banks globally. What’s more, these funds are likely to be operated by the same firms. JPMorgan, for instance, now runs a bank, a securities dealer, and an asset management business — but via separate entities because of regulation.

Much like the onshore system, the Eurodollar system connects cash lenders and borrowers via dealers and dealer banks’ “matched books”. Dealers provide dollar liquidity by borrowing dollars and lending them out, earning a profit from the spread.

So when a lot of commentary paints a picture of the Eurodollar system as mysterious and obscure, we would push back a little. The narrative that it’s a totally opaque system that exists in a parallel world is somewhat peculiar. Firstly, Fed Funds and Eurodollars are considered by the top financial behemoths to be almost fungible. The main difference is that Fed Funds can only be loaned out to those with a Federal Reserve master account (which grants access to the Fed Funds market), while a wider range of financial institutions can access Eurodollars. Regulators and authorities also not only keep track of Eurodollar transactions through brokerage data (yes, there are actually brokers for bank reserves) but they have permitted and encouraged what some deem illicit Eurodollar transactions for decades.

The modern Eurodollar is simply dollar funding and banking offshore that settles onshore, only because the U.S. empire has yet to set up the infrastructure to settle payments between banks outside its borders. This means the Eurodollar market allows foreign banks to go into the dollar lending business without having direct access to the Fed’s balance sheet. Only a few entities are authorized by the Fed to hold bank reserves — which are liabilities of the Fed — on their books. Everyone else must engage in “global regulatory arbitrage,” collaborating with entities that have access to the Federal Reserve System to settle dollar payments. There’s even a thriving market for Eurodollars within the U.S. because not all financial entities operating onshore that require dollar funding have access to the Fed’s balance sheet. Bank reserves cannot leave or be used outside the Federal Reserve System, let alone the real economy.

Another inaccurate description we see often is that banks outside the U.S. are just creating unlimited dollars out of thin air. In reality, banks active in the Eurodollar market are more careful about who they lend to because they do not have access to an immediate lender of last resort .i.e the Fed. Their central bank will have a swap line agreement with the U.S. central bank to access dollars in times of crisis, but it is not assured and not imminent. The U.S. security pact encourages global finance to provide a steady stream of dollars overseas so that the Fed and the Treasury can focus more on domestic monetary issues and avoid having to administer a global dollar policy. Still, all the Fed and U.S Treasury have to do to become the international dollar lender of last resort is fire up swap lines and the Fed’s FIMA facility (for China), whenever the supply of offshore dollars grows scarce.

Coincidentally, the supply of unsecured offshore dollar funding has dried up. After the GFC (Great Financial Crisis), a series of stringent regulations imposed on banks reduced the supply of Eurodollar funding, seemingly forever. The Basel Framework’s LCR (Liquidity Coverage Ratio) — which requires 1:1 backing of stable funding (reserves) for every short-term unsecured dollar raised — destroyed the major motivation to transact in Eurodollars. Then, shortly after, the SEC’s money market reform in 2014 caused a silent run on prime money market funds, the main liquidity source for Eurodollars. Eurodollar volumes today still average around $100 billion daily, but that pales in comparison to before the GFC.

Ultimately, the Eurodollar system is still active but plays a less significant role, not because the U.S. dollar is dying, but because of global regulatory changes. In the new “SOFR standard” that monetary leaders have enforced, secured debt instruments (like repos) have superseded their unsecured debt counterparts (like commercial paper), which provided the most unsecured offshore funding. As the effects of this monetary evolution have yet to be felt, we’re now in “secured but uncharted” territory.

That’s a wrap! We’ll cover Eurodollars again in relevant future pieces. If you have any queries or need clarification on any minor details, leave a comment below.

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To help accomplish this, below is an infographic from our upcoming piece, an overview of the most crucial dollar funding market: repo. We’ll use it to demystify the various rates that make up the arcane U.S. money market complex.

But before we begin, some context. Money markets are markets for lending and borrowing money efficiently. For this to occur, dealers must provide liquidity by running “matched books,” which look like a typical balance sheet (see the “triparty repo market makers” section in the infographic). Dealers borrow cash using a repo and lend it out in a reverse repo, earning a profit from the spread they charge — the difference between the rate they lent and borrowed.

Going forward, everything makes a lot more sense when you think in terms of liquidity providers making markets (and trying to earn a spread) by intermediating between cash borrowers and cash lenders.

Now, with that in mind, let’s decipher every money market rate.

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A lengthy attempt to eradicate risk from the global financial system, by both monetary authorities and major financial actors, is approaching its climax. What began as a panic reaction to the 2008 subprime crisis has transformed the way financial entities do business. The GFC (Great Financial Crisis) was a crucial turning point in how banks perceived risk. After decades of working on the flawed assumption that an ecosystem built on stark complexity had grown indestructible, they changed their perspective.

No longer believing in the fiction that lending between banks had become riskless, they saw a system fraught with peril. The major flaw of finance, where protection turns into the very thing that prompts a meltdown, had even threatened the most systemically important benchmark. In August 2007, as the subprime crisis began to unfold, the most critical interest rate globally had detached from its counterparts, the same number used to price well over $300 trillion in financial products: the London Interbank Offered Rate, known as LIBOR.

The rate that the world relied on to price everything, from business loans and securitizations to adjustable-rate mortgages and private student loans, had gone haywire. But this shouldn’t have come as a surprise. It’s just that everyone had dismissed LIBOR’s dubious origins.

It all began after the U.S. promoted globalization, post-WWII. In the 1950s, London grew into a global financial hub, since U.K. banks had the most freedom to finance prohibited dollar transactions. The Bank of England found out, but penalizing the bankers for mischief meant curbing global commerce.

Under the security pact America signed with almost every other nation, the financial behemoths quickly took advantage. The U.S. banks set up branches not just in the U.K. but worldwide, while non-U.S. banks set up branches in America. Hot money flowed into U.K. banks from other major powers. Among them were America’s main rivals (Russia, China, and many Arab states), who chose to keep their dollars outside America for political reasons, mostly out of fear that their funds could be frozen. As a result, financial alchemy flourished.

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