The ‘HedgeRepo’ concept: Using credit derivatives as repo collateral

Abstract

This paper discusses the concept of the HedgeRepo (trademarked and patent pending—HedgeRepo shall mean HedgeRepo™) paradigm, which integrates derivative-based hedging, repo financing, collateral and counterparty risk management in a single repo-style instrument. This paper discusses a particular example of this paradigm, which is the use of credit derivatives—specifically credit default swaps (CDSs)—as repo collateral. Integrated collateral and counterparty risk management are performed in repo financing of high yield bonds, and the qualitative and quantitative benefits of such integration are also explored. The paper is organised in two parts. The first part provides some background information on repo trades and CDSs. It also describes the trends in the marketplace and the shortcomings in current risk management practice in repo trades. The second part discusses HedgeRepo and related information. The benefits of HedgeRepo are explained and numerical examples of repos are provided where CDSs are used as additional collateral in financing a portfolio of high yield bonds. These illustrate the advantages of applying the HedgeRepo concept. The potential practical uses of HedgeRepo in the context of CDSs and high yield bond repo markets are listed.