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Moved from Comments: Primary Dealers and Matched Book Repo

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Hi Joseph,

“The Primary Dealer borrows money from a money market fund via the repo market to make the purchase. The Treasury purchased is immediately pledged as collateral for the money market fund’s repo loan. The Primary Dealer will repay the repo loan using the proceeds it receives from selling the Treasury to the Fed.”

I think there is generally a lot of confusion surrounding Primary Dealers and what else they do and may be worth a blog post. For example, how can a PD pledge a security that it hasn’t bought yet with the MMF’s loan? What is the accounting for this... Wouldn't a PD need to pledge an existing security immediately upon entering the repo agreement? The only thing I can think of is that this may be a result of the delay in settlement period of repo so that the collateral can be delivered later on into the pledge? Doesn't make sense though if it is legally a true sale and you reverse it the next day...

Would you also be able to explain if the above description is the same thing as “matched book repo”? Or does matched book refer to re-hypothecating within the same day? It would be helpful to understand how primary dealers run these matched books. Is this the market-making function of PDs, or the providing clients funding function of dealers?

You also had the JPM illustration where primary dealer balance sheets had changed as a result of clearing through FICC. Can you explain how that works and why that is less balance sheet intensive? If I am to hazard a guess, it is simply because when you transact as a PD with two counterparties (for e.g. a hedge fund and a money fund a.k.a cash borrower and cash lender), you have a gross exposure to each on the B/S, while trading with the FICC on both legs can be netted out (even though for accounting purposes it is still on B/S)?