How Does Policy Affect Trading Relationships? Evidence from the U.S. Repo Market

We analyze changes in monetary and regulatory policy on trading relationships in the U.S. repo market. We estimate that when the Federal Reserve (Fed) introduced its reverse repo (RRP) facility, money market mutual funds (MMFs) eligible to lend to the Fed cut their lending in the triparty repo market to broker-dealers (dealers) by 16%, on average. By providing a backstop, the RRP facility shifted bargaining power towards MMFs eligible to lend to the Fed, and away from dealers. Although the RRP facility strengthened trading relationships between MMFs and dealers, it also prevented some foreign dealers, who were subject to less stringent implementation of the Basel III leverage ratio, from engaging in regulatory arbitrage as effectively. We find that these policy changes influenced the way MMFs managed their balance sheets and made MMFs that were eligible to lend to the Fed safer.