General Collateral Financing Trades (GCF): Meaning, How it Works

What Are General Collateral Financing Trades?

General collateral financing (GCF) trades are a type of repurchase agreement (repo) that is executed without the designation of specific securities as collateral until the end of the trading day. GCF trades utilize several inter-dealer brokers, who act as intermediaries for the GCF trades. GCF trades allow both borrowers and lenders in the repo market to reduce their costs and decrease the complexity of handling securities and fund transfers for repo agreements.

Understanding General Collateral Financing Trades (GCF)

Repurchase agreements, or repo trades, are essentially short-term loans usually made between banks or between banks and other corporations that hold a large amount of corporate bonds, government bonds, cash or both. The idea behind these trades is quite simple, though the execution of them can be complex.

In essence, a bank or other lending institution has a large amount of cash and would like to lend it out at whatever rates it can get. Because banks are able to lend on reserves, they can turn a minimal interest rate into something substantially better if they can make short-term loans on high quality assets. Corporations or banks who hold a substantial amount of high-quality bonds may be in a position to make a substantial profit, if only they can raise short-term cash.

Repurchase agreements allow both of these parties to benefit. The bondholders use the bonds as collateral to get cash through a repurchase agreement. It acts like a loan because the agreement stipulates that the bondholders will pay more to repurchase the assets than they sold them for. The counterparty (usually a bank) is guaranteed a profit so long as the transaction is not defaulted. The GCF trade is a version of this that streamlines the process.

Special Considerations

Since GCF trades are often between banks or banking institutions, the initiating party can assume the counterparty has a significant amount of high-quality assets on hand, and can enter into the transaction with little worry for the details of the assets being used for collateral. This is especially useful if the transaction is open and closed before the end of the day.

General collateral (GC) comprises high quality, liquid assets that are close substitutes to one another—hence, they are lumped together as "general" collateral. U.S. Treasury bills, notes, and bonds are accepted as GC, as are U.S. Treasury Inflation Protected Securities (TIPS), mortgage-backed securities, and other securities issued by government-sponsored enterprises.

Because these forms of collateral are virtually cash, there is greater market liquidity and repo transactions are facilitated without the need to negotiate individual collateral agreements between lending and borrowing dealers. Moreover, participants benefit from lower costs, as GCF trades are based on rates close to money market benchmark rates such as LIBOR and EURIBOR.

The delay granted in specifying the exact collateral for the repo is advantageous for borrowers, who are then able to utilize the securities they have on hand to clear other, unrelated trades as necessary throughout the day. This avoids the time-consuming process of swapping collateral if it becomes needed by the borrower. GCF trades are also advantageous in that the use of the inter-dealer broker allows borrowers and lenders to net out all of their GCF repo obligations at the end of each trading day, greatly decreasing the number of costly securities and fund transfers that must take place.