DVP Repo #primers

DVP (Delivery Versus Payment) is a quirky way to describe such a simple concept as exchanging cash for specific securities. DVP is simply the centrally-cleared “Bilateral” Repo Market run by the FICC.

“Bilateral” repo is a dealer-to-customer repo market, where the specific security pledged as collateral is desirable to the cash lender. Just like other segments, dealers connect cash lenders and cash borrowers. Hedge funds, however, are the major borrowers and lenders in DVP, because of this segment’s ability to facilitate leveraged trades. They know the exact collateral they are promised from cash borrowers, which is usually the cheapest to deliver (CTD) into a futures contract. Sourcing a CTD security is the backbone of the most popular leveraged trade among relative value hedge funds (RV funds), known as the “Treasury-Futures Basis Trade” (pic related).

The dispersion of rates in DVP is the widest. Hedge funds will not only be charged the highest spread from primary dealers, who’ve borrowed from cash lenders in triparty (see the red flows in the infographic). They will be borrowing at incredibly lower rates in the “specials” market (see the specials section in the infographic). This is where the trading of securities subject to high demand in the repo and cash markets occurs. Rates on specials fall below even the ON RRP rate set by the Fed (the so-called risk-free rate in repo).

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