Ready Forward Contracts in Treasury Management

It is a transaction in which two parties agree to sell and repurchase the same security. Under such an agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date in future at a predetermined price. Such a transaction is called a Repo when viewed from the prospective of the seller of securities (the party acquiring fund) and Reverse Repo when described from the point of view of the supplier of funds. Thus, whether a given agreement is termed as Repo or a Reverse Repo depends on which party initiated the transaction.

              The lender or buyer in a Repo is entitled to receive compensation for use of funds provided to the counter party. Effectively the seller of the security borrows money for a period of time (Repo period) at a particular rate of interest mutually agreed with the buyer of the security who has lent the funds to the seller. The rate of interest agreed upon is called the Repo rate.

              The Repo rate is negotiated by the counter parties independently of the coupon rate or rates of the underlying securities and is influenced by overall money market conditions.

The motivation for the banks and other organizations to enter into a ready forward transaction is that it can finance the purchase of securities or otherwise fund its requirements at relatively competitive rates. On account of this reason the ready forward transaction is purely a money lending operation. Under ready forward deal the seller of the security is the borrower and the buyer is the lender of funds. Such a transaction offers benefits both to the seller and the buyer. Seller gets the funds at a specified interest rate and thus hedges himself against volatile rates without parting with his security permanently (thereby avoiding any distressed sale) and the buyer gets the security to meet his SLR requirements. In addition to pure funding reasons, the ready forward transactions are often also resorted to manage short term SLR mismatches.

Internationally, Repos are versatile instruments and used extensively in money market operations. While inter-bank Repos were being allowed prior to 1992 subject to certain regulations, there were large scale violation of laid down guidelines leading to the ‘securities scam’ in 1992; this led Government and RBI to clamp down severe restrictions on the usage of this facility by the different market participants. With the plugging of loophole in the operation, the conditions have been relaxed gradually.