A chronicle of repurchase agreements (RP) and other paradoxical property ownership contracts - www.omo.co.nz

Emailed, Tuesday, 1 July 2003 16:13

Mr A Orr
The Head of Financial Stability Department
Cc: Dr Michael Cullen, Minister of Finance      


Dear Mr Orr

I have had occasion over the last year to engage the Minister of Finance in a discussion concerning the appropriateness of injecting Crown surpluses through the RBNZ OMO liquidity management window. I contended that the recycling of burgeoning surpluses through the reverse repo mechanism while continuing to issue net new Government debt was tantamount to printing money. He (Dr Cullen), in a letter, dated 21 August 2002, refuted such assertions of underhand activity but, nevertheless, acknowledged that a large ongoing balance in the Crown account at the RBNZ is not ideal. He went on to state that "...Our planning this year allows for the balance to drop away markedly later this financial year..." Unfortunately, this is not the case. Outstanding RBNZ   reverse repo and currency swaps suggest a figure close to $3.152 billion as of 30 June 2003.

This situation gives me cause me to ask you to consider the regulatory/supervisory issue of accepted repo accounting rules within the context of concerns raised by the Reserve Bank of India when they had to address a series of market dislocations brought about by misuse of the repo market. I refer, in particular, to their comments -Section 3.11,..."In the case of repos where the transactions were permitted with restrictions, the irregularities revealed that some banks used repos to understate their actual liabilities , by advising nonbank customers to lend them money by way of repos rather than place the same in the form of deposits . Some other players went to the extent of first committing to borrow repo funds and only then investing the same in securities, such that the position in securities would not have been there but for the commitment of these repo funds ."   Emphasis added. Consequently a false market in Government debt is created. Which, incidentally, I do not believe is among the RBNZ's chartered duties.

The facility to achieve this type of activity is contained within the generally accepted accounting practice, as stated in the RBNZ 2001/2 Annual Report , page 10.

" Repurchase and Reverse-Repurchase Transactions

Securities sold under agreements to repurchase continue to be recorded as Marketable Securities in the Statement of Financial Position. The obligation to repurchase is disclosed within liabilities as Securities Sold Under Agreements to Repurchase. The difference between the sale and repurchase price represents an expense and is amortised over the term of the contract and reported in the Statement of Financial Performance. Securities held under reverse-repurchase agreements are recorded within assets as Securities Purchased Under Agreements to Re-sell. The difference between the purchase price and sale price represents income and is amortised over the term of the contract and reported in the

Statement of Financial Performance.

Both repurchase and reverse-repurchase transactions are reported at the transaction value inclusive of any accrued income or expense."

Similarly, The National Bank of New Zealand Ltd in their latest financial report , page 17, makes this disclosure,

Notes to the Financial Statements (continued)

Note 1 Statement of accounting policies (continued)

O Repurchase and reverse repurchase agreements

Securities sold under repurchase agreements are recorded as assets with the proceeds recorded as interest bearing deposits. Securities purchased under repurchase agreements are recorded as interest earning assets.

In both cases it is clearly stated that securities sold under repurchase agreements by one party are recorded as assets (presumably, available for sale?), while those same securities purchased under repurchase agreements by the counterparty are also recorded as assets (certainly, available for sale). This agreed accounting procedure allows the same assets to be simultaneously recorded as owned by two different and independent financial counterparties.

It is this 'sleight of hand' practice that, in the best case, understates the liabilities of RBNZ approved repo counterparties and in the worst case facilitates unbridled balance sheet leverage. May I suggest you review current regulatory policy in respect of repo trading activity and accounting and possibly adopt a more conservative non market distorting regime demanded by the Reserve Bank of India ;- Section 3.8 -, ..." As far as accounting is concerned the RBI Circular dated April 15, 1987 insisted that no sales of Government and other approved securities under the arrangement should be effected by banks unless the same are actually held by them on their own investment portfolio either in the form of actual scrips or in SGL account maintained with Reserve Bank. The banks also required to deduct the securities sold from the investment account of the bank and its SLR assets for the entire period of holding by the purchaser/counterparty."      

Please note, I am not opposed to the RBNZ in their current capacity. I don't believe I would ever indicate as much. Yet, I am an opponent of certain types of policy conduct. After all, who would I have conduct monetary policy? Our national legislators? The Treasury and what party biases might be present or agendas serviced?


Yours faithfully


Stephen L Hulme




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OMO Matters

US Federal Reserve Reference Publications

"The market for repurchase agreements on US government securities is of vital importance to the New York Fed, and the whole Federal Reserve System, because it is where virtually all of our monetary policy operations are conducted."- Peter Fisher, Manager, System Open Market Account - 15 January 1997.

"Open market operations are not another weapon in the Fed's arsenal, but the only weapon in its arsenal." - Monetary Trends, St Louis Federal Reserve, August 2003.

Repurchase Agreements with Negative Interest Rates - FRBNY - A primer detailing how short sales of Treasury securities can lead to protracted RP fails and consequently negative rates to address capital requirement issues.

OMO-Repo Misuse - Letters to Hon. Dr. Michael Cullen, N.Z. Minister of Finance.

Repo Transaction Accounting. Letter to Mr A Orr, RBNZ.

IMF Repo Accounting Examples, Full Article

NZ Debt Management Office Uridashi issue and associated EuroKiwi letters to Hon. Dr. Michael Cullen, N.Z. Minister of Finance.