Here Comes The Repo Man

Contrary to the title of the blog, we aren’t going to repossess anything. Quite the contrary actually. I can usually tell when people get nervous about a certain topic simply based on the number of emails I get to my inbox. This week was no exception after the BOC made an announcement on Friday:

As of July 15, 2024, the Bank of Canada (BOC) increased the dealer limit for Overnight Repo (OR) operations to $3 billion for each eligible participant. This is an increase from the previous limit of $1 billion. The BOC also increased the maximum cash value amount offered in each auction to $8 billion, up from $5 billion.

The announcement seems to have thrown some people for a loop, and left many more wondering what the hell is going on. Interestingly enough, the people who are preying for a housing collapse see the announcement as a bad thing, and the real estate bulls see it as a good news event. In reality – it is neither, and nothing more than business as usual at the BOC.

Back in May 2024 the Securities industries in both Canada and the US moved from T+2 to T+1. T+2 had been the standard for the settlement of securities, stocks, etc. for decades. It basically meant that the trade had to settle and the swapping of products done within 2 days AFTER the trade date (T) . So, if you sold a stock in your account on Monday (T), Tuesday was + 1, and Wednesday was + 2, meaning by Thursday the trade had to be settled. That means for said stock, the buyer had to have received the stock, and the seller had to receive the cash. People in securities circles long talked about T+2 being too long and obsolete. It todays world where you can do anything almost instantly I agree that 3 days to settle a trade was a bit long. T+2 was a realistic goal back before the internet, and where most trading was done by brokers over the phone, but with the advent of electronic trading, the internet, online brokerages etc., T+2 was quickly becoming the stock market ice age. We had T+2 trading at the same time mortgage brokers had to originally fax an application to a company like Firstline Mortgages, wait 3 days to hear back on the app, and then have the approval letter faxed to us. A lot has changed in the mortgage business, so why shouldn’t it change in the investment business?

So, the securities regulators got together in Canada and the US, and decided to move from T+2 to T+1. Now, why am I going on and on about stocks, securities, and mutual funds on a mortgage blog? Well, mortgages aren’t a security per se ( sometimes they are ) however, when you take a bunch of CMHC mortgages and package them up into bonds, they now become a security – just like a stock. Canadian Mortgage Bonds ( CMB’s ) are nothing more than a security that can be traded in your online brokerage account, by your stock broker, and by traders around the world. Since they are classified as a security then they fall into the purview of the Canadian security Administrators, and are subject to trading rules imposed by the CSA.

When Canada and the US changed to T+1 back in May they announced it loud and clear for the world to hear that there was a good chance that cutting the extra day off the settlement period would increase the required liquidity in the system. On Friday, when the BOC announced an increase to the repo limits, a lot of it had to do with the increased liquidity requirement for the T+1 settlement. This was well choreographed back in May. Since the change took place in later May, it took the BOC, the CSA, and all market participants a few weeks to realize the timing, the amount, and the required dollars for the increase. Friday’s announcement was the culmination of this work.

So, this is nothing to really get worked up about – no matter what you may read on Twitter, Social media, or that rambling conspiracy theorist who lives down the street may say. This is just some fine tuning on the BOC overnight repo operation that was expected.

But, and there is always a but, I am a little shocked at a couple of items. First and foremost, I am a little taken aback at the size of the increase. I did not personally feel that a 200% increase in the limit was needed ( 1 billion to 3 billion ), and secondly, making the announcement at 2:00 pm on a Friday always tends to get the conspiracy theorists up and running around. Why announce the change with 2 hours left in trading on a Friday afternoon, when the senior traders are all at the cottage? The BOC needs to learn from its past mistakes and read a room so to speak, and not make announcements that they should know will get people riled up. The policy also goes into affect Monday morning at 9:00 am. Next time the BOC needs to announce this type of thing Wednesday at 11:00 am, and have it go into affect 2 weeks from now. Give the market time to digest the news, trade for a couple of days on it, ask question to senior BOC staffers, and allow calm to set in.

The only thing that has me a tad worried about the repo announcement is simply the sheer size of the increase. A 200% increase to the limit is a lot more than I can think would be needed with a change from T+2 to T+1. However, the BOC may also see some rough waters ahead for banks in the current environment, and took the opportunity to increase the overnight repo limit now to help better handle stormy seas ahead.

Let’s say that the BOC had wanted to increase the limit from 1B to 2B per participant. Well, if they see some tough times ahead, and a potential liquidity problem on the horizon, they would simply raise the limit now to 3B per participant, and then if problems did indeed arise this fall, then the limit had already been raised under the guise of the T+1 settlement change. However, if they raised from 1B to 2B now, and THEN had to raise from 2B to 3B if a problem arose in the future, it would send panic and shockwaves, and potentially cause a liquidity problem in the open market. Panics in money markets are the worst kind of panic, so perhaps raising the limit as much as they did now was to heed off future demons? Perhaps I am just out of touch with the impact of the T+1 settlement change and the 200% increase was required?

Also, for the record, this has nothing really to do with Uncle Tiff. This was one of the departments at the BOC that Tiff really doesn’t get super involved with. Of course Tiff is the Governor of the BOC, and repo operations are within his realm, but an announcement like this is simply delegated to a different department. It is akin to the CEO of a company being involved with the landscaping department that trims hedges at a factory. While Tiff may get personally involved in repo operations as part of QE or QT during a crisis, a mundane thing like the T+1 settlement change isn’t likely to be enough for him to ride the elevator to a different floor to get involved with.

If you have a client ask you what it all means, you can give them a simple explanation that will help them out: This announcement is the equivalent of RBC increasing your overdraft protection from $1,000.00 to $3,000.00. Not a big deal really.