Similarities and differences between repo and FX swap markets
This paper by Wenxin Du, Georg Strasser, and Adrien Verdelhan examines US dollar funding markets in Europe by analyzing transaction-level data from large euro-area banks in both repo and foreign exchange (FX) swap markets during 2021-2024. The authors employ confidential supervisory data from the European Central Bank covering actual transactions at the institution level. The repo data come from Securities Financing Transactions Regulation (SFTR) reporting, while FX swap data come from Money Market Statistical Reporting (MMSR). The sample includes 46 major euro-area banks (MMSR banks) and covers contracts with maturities up to one year. By matching transactions across both markets at the bank level, the study provides the first comprehensive view linking these two critical dollar funding sources.
The authors also develop a theoretical model featuring a dealer intermediating in both markets, subject to balance sheet leverage constraints and exercising market power. They test the model’s predictions using event studies around quarter-ends when regulatory constraints tighten.
Findings
- Market substitution and intermediation patterns: Repo and FX swap markets function as close substitutes for large European banks. MMSR banks are net borrowers in the repo market (€100-300 billion) and net lenders in the FX swap market (€100-200 billion), with their combined net position across both markets typically near zero despite gross exposure of €1.9 trillion, demonstrating their role as major intermediaries of global dollar liquidity.
- Balance sheet costs and pricing differences: Balance sheet costs create significant pricing differences between markets. The average spread between repo borrowing and lending rates is 8 basis points during normal periods, widening to 19 basis points at quarter-ends. In contrast, FX swap markets show minimal spreads (1 basis point) because matched-book FX intermediation remains largely off-balance-sheet. MMSR banks earn approximately 10 basis points on average by borrowing in repo markets and lending in FX swaps, compensation for balance sheet usage that increases to 34 basis points at quarter-ends when regulatory pressures intensify.
- Dealer market power and price dispersion: Dealer market power produces substantial price dispersion across counterparty types despite similar balance sheet impact. MMSR banks borrow at rates 10-20 basis points lower than those charged to non-MMSR counterparties in FX swaps, with the largest spreads observed when trading with non-financial firms.
Repo and FX Swap: A Tale of Two Markets
Authors: Wenxin Du, Georg Strasser, Adrien Verdelhan
From: Harvard Business School, European Central Bank, MIT Sloan School of Management
Who moves currency markets? Evidence from 100 million FX derivative trades
Sinem Hacıoğlu-Hoke, Daniel Ostry, Hélène Rey, Adrien Rousset Planat, Vania Stavrakeva, and Jenny Tang, in this paper, employ a novel dataset comprising over 100 million FX derivative transactions in the London market from January 2015 to December 2020, accessed through the European Market Infrastructure Regulation (EMIR) Trade Repository. The authors construct daily firm-level net FX derivatives exposures for more than 16,000 firms across all major market participants—including pension funds, investment funds, hedge funds, insurers, dealer banks, non-dealer banks, non-financial corporations, and non-bank market makers.
The methodology combines theoretical modeling with empirical analysis. The authors develop a partial equilibrium framework that decomposes firms’ FX derivatives use into speculative and hedging components, based on the persistence and directionality of net exposures. They use firm-level panel regressions to examine how different sectors adjust their positions in response to carry trade opportunities, momentum strategies, and macroeconomic news.
Findings
- Hedging vs. speculation: Non-financial corporations, pension funds, investment funds, and insurers primarily use FX derivatives for hedging, maintaining persistent net-short USD positions to hedge on-balance-sheet dollar exposures. Over 60% of individual non-financial corporations maintain one-sided USD exposures for at least 95% of the sample period. In contrast, hedge funds are speculators—their exposures frequently shift between net-long and net-short, adjusting positions in accordance with carry trade, momentum, and macro news strategies.
- Dealer banks as intermediaries: Dealer banks act as “toll-takers”, remaining neutral to investment strategies while taking offsetting positions between speculators (hedge funds) and hedgers (non-financials, pension funds), thereby insulating themselves from speculative demand changes.
- Exchange rate transmission: Hedge funds play a crucial role in transmitting monetary policy shocks to exchange rates—greater hedge fund exposure to a currency following a monetary policy tightening is associated with currency appreciation. Investment funds contribute to flight-to-safety dynamics, with increased USD exposure during rising credit risk associated with dollar appreciation. A reduced-form regression using all client sectors’ positions yields a 66% correlation between predicted and actual weekly exchange rate movements, with hedge funds and non-financial corporations being most informative.
Topography of the FX Derivatives Market: A View from London
Authors: Sinem Hacıoğlu-Hoke, Daniel Ostry, Hélène Rey, Adrien Rousset Planat, Vania Stavrakeva, Jenny Tang
From: Federal Reserve Board, Bank of England, London Business School, Federal Reserve Bank of Boston
