A Brief Introduction About the Reverse Repurchase Agreement
The reverse repurchase agreement is one of the major tools used by many banks, financial organizations, and business firms. The short term agreements help in providing lending opportunities to assist funding operations for a temporary time period. In this agreement, securities are bought to resell or are returned back in the near future at revenue. The party which wants to buy security has to sign an agreement on which it should be sold back. What is a reverse repurchase agreement? It might be difficult to understand at first, but it is nothing more than a security purchase, which helps to sell them in the future at a higher price on a specific date.
The parties who are selling this agreement definitely want it back in the future, and that’s why this agreement is to be signed by both the parties. These are for short-time period lending or borrowing, and mostly it happens overnight. The time period to repurchase the security can be after one day, or it can be after two years.
Who Takes the Reverse Repurchase Agreement?
This agreement is quite a common tool for open market bank operations. The repurchase agreement is a kind of borrowing option for dealers for a short time period. The reverse of it is the reverse repurchase agreement. Do you know what repo transaction is? The money which is transacted by the dealer to investors overnight can be known as repo transaction.
Later on, it is bought back at a higher price. The major reason due to which an organization can enter this transaction is to ensure financing the security purchase and fund balance sheet.
Purpose of the Reverse Repurchase Agreement
Sometimes, the bank holds securities which it doesn’t need and also doesn’t want to liquidate. In this case, repo agreements are of good use. The major players in this agreement are the financial institutions with government security portfolios. Sometimes, there are primary dealers who hold government securities in large inventories and then repo them out for cash. The main purpose is to benefit both lender and borrower with fast and immediate borrow and lending services.
Contents of the Reverse Repurchase Agreement
The reverse repurchase agreement accounting has to be done by a professional accountant, and it should be agreed by both the parties.
It should include
- The names of both organizations should be mentioned along with the repo amount.
- The date on which it should be returned back should be mentioned, and the amount to be returned is also added in the agreement.
How to Draft the Reverse Repurchase Agreement?
Both the sale and purchase price has to be determined before signing the agreement as it needs to be mentioned in the agreement clearly.
- Declaration of the time period and start date of the transaction
- Names and signatures of the parties
- State what closing costs the seller must pay
- Explain who pays the taxes
- Identify options if the inspection is unsatisfactory
- mention the termination clauses
- Steps to include in case of any breach of contract takes place
The reverse repurchase agreements have become a major part of the money markets. If you want to draft this agreement, then you can take the help of a professional attorney who can help you to write all the necessary clauses and rules regarding it. There won’t be any chances of dispute and confusion if the agreement has been made in the presence of a good lawyer.
There are almost zero chances of negotiation in the reverse repo agreement after it has been signed. Even if someone wants to negotiate on a particular basis when one takes the help of a professional lawyer. The attorney can guide you on this. Negotiations can be made before signing the agreement regarding the return date, and you can also negotiate for the amount to be repurchased back by you.
Benefits and Drawbacks of the Reverse Repurchase Agreement
There are several types of benefits of this agreement, and that’s why several organizations in the money market opt for it. This is a kind of overnight reverse repurchase agreement, and that’s why it is a nice option for both borrowers and lenders.
However, just by lending security for one night(1), the lender has to purchase it back at a higher price.
For this, you can take the help of a professional attorney before signing such an agreement with an organization.
What Happens in Case of Violation?
In case someone violates rules and regulations of repo agreement, then it can be really harmful as one might have to pay a huge amount of fine. These agreements are quite sensitive, and all the clauses and obligations mentioned in the agreement should be followed strictly by both parties. None of the parties must violate any law written in this agreement, and if someone does, then one has to pay for it.
Whenever a company needs money within few hours and can return it overnight, then the reverse repurchase agreement is really useful. It is used from time to time by the banking and financial instructions in the market. There are several countries where the agreement is signed by institutions in the money market, as it is quite beneficial for both- the lender and the borrower.