Repurchase Agreements and TBA Pools: Asset Management Risk Insights

Asset Management Risk Insights

Institutional investment programs present unique challenges and complexities that require asset managers to develop a deep understanding of financial markets, operational controls and regulatory requirements. Leaders responsible for navigating this complex market must understand key risks in order to manage them.

Technical risk considerations in asset management extend beyond specific asset classes to include valuation practices, regulatory requirements and operational processes. Together, these elements shape how investment strategies are executed, monitored and controlled within institutional portfolios.

Fixed Income Investments: Repurchase Agreements and TBA Pools

Fixed income trading in repurchase agreements (repos) and to-be-announced (TBA) pools can play a vital role in managing liquidity, yield enhancement and portfolio construction within investment portfolios. However, these fixed-income instruments are uncommon and structurally complex. Their complexity introduces a wide range of financial, operational and compliance risks to organizations that use them.

The opaque, over-the-counter nature of repo and TBA markets — combined with the potential for leverage, counterparty exposure and manual trade processes — requires robust internal controls and targeted audit oversight. To use these investments successfully, organizations must first understand their risks, then incorporate controls and oversight to manage those risks appropriately.

Some key risks related to repos and TBA pools are listed below, along with protections that organizations can put in place to guard against them.

Key Trading Risks in Repos

A repo is a short-term borrowing mechanism in which one party sells a security to another with the agreement to repurchase the same security at a specified price at a future date. Repos are often used by institutional investors to manage liquidity and collateral requirements.

1. Counterparty credit

The counterparty in the repo transaction may fail to fulfill their obligation, either by not repurchasing the securities at the agreed-upon price and time or by defaulting on the loan. This risk is increased during times of market stress.

Considerations:

• Perform due diligence over potential counterparties (e.g., credit ratings, financials)
• Test compliance with counterparty exposure limits
• Verify existence and appropriateness of master repurchase agreements (MRAs) or global master repurchase agreements (GMRAs)
• Confirm the use of an approved counterparty list and internal credit assessments

2. Collateral

The value of the collateral pledged (e.g., U.S. Treasuries, agencies, mortgage-backed security (MBS)) may decline, leading to insufficient coverage of the loan amount. This risk rises if the collateral is not highly liquid or if its market value fluctuates significantly.

Considerations

• Evaluate haircuts (percentage reduction to the market value of the asset) applied and compare them to market norms and policy
• Test the timeliness and accuracy of daily mark-to-market collateral valuations
• Review margin call processes, including triggers, calculations and timeliness of responses
• Assess controls over collateral substitution and eligibility criteria
• Evaluate implementation of initial and variation margin requirements to ensure adequate collateral coverage throughout the life of the repo and appropriate accounting of margin receivables and payables

3. Liquidity

If the repo collateral cannot be liquidated quickly enough to cover the defaulted amount, it may be difficult to sell the collateral quickly without incurring significant losses, especially in times of market stress.

Considerations

• Review the maturity ladder of repos and assess rollover or concentration risk
• Confirm that cash forecasts include repo settlements and test cash-flow projections to confirm adequate liquidity coverage
• Assess the stress-testing process for liquidity in scenarios of market dislocation or repo market tightening
• Inspect stress-testing scenarios and assumptions for repo roll-off, collateral volatility, margin call scenarios and haircut changes

4. Interest rate

Changes in interest rates affect the value of securities involved in a repo. If interest rates rise, the value of the collateral may decrease, potentially leading to losses.

Considerations

• Review strategy for managing rate exposure, especially for term repos
• Assess how changes in repo rates affect total return on leveraged or cash management strategies
• Verify that floating vs. fixed repo terms are accurately captured in interest rate risk models

5. Operational

Operational failures in trade execution, settlement or collateral management can cause repo market losses. Trade entry errors, miscommunication or system breakdowns can lead to failed trades or incorrect collateral delivery.

Considerations

• Evaluate trade capture and confirmation workflows for segregation of duties and dual authorization
• Review post-trade reconciliation processes with custodians and counterparties
• Test repo trades for accuracy in booking, settlement and collateral allocation

6. Trade allocation and aggregation

Trades executed in aggregate for multiple portfolios (e.g., pension, endowment or trust funds) may be misallocated, leading to performance, compliance or fiduciary breaches.

Considerations

• Review policies for bunched trade allocations, especially for cash or collateral movement
• Test that trade allocations are pro-rata and in line with predefined allocation rules (e.g., based on asset size or funding need)
• Confirm that allocations are completed promptly, ideally on trade date (T+0 or early T+1)
• Assess system automation of trade allocation versus manual inputs for risk of error or manipulation

7. Legal documentation

Legal uncertainties due to inadequate or unclear legal documentation, which can lead to disputes and enforcement issues. Unclear or inconsistent legal terms may create ambiguity in default, margining or netting scenarios.

Considerations

• Verify use of standardized legal agreements, such as an MRA or GMRA
• Verify legal review and centralized storage of MRAs/GMRAs
• Ensure documentation is up to date and includes key clauses (e.g., events of default, netting provisions)
• Confirm alignment with internal repo policy on legal terms (e.g., termination rights, margin call timelines)

8. Valuation

Inaccurate valuation of repo positions or collateral could lead to misstatements in net asset value (NAV) or risk exposures.

Considerations

• Review pricing sources and hierarchy (e.g., ICE, Bloomberg) used for repo and collateral valuation
• Confirm daily valuation and reporting to investment and risk teams
• Validate accounting entries for repo trades, particularly under GASB (for public funds) related to secured borrowing vs. sales treatment

9. Compliance

Noncompliance with regulatory requirements or internal policies can lead to fines, sanctions and reputational damage. The regulations potentially triggered by repos — such as SEC rules — could involve capital, liquidity and leverage.

Considerations

• Review order management system (OMS) pre-trade and post-trade compliance logic to ensure that logic for repo and reverse repo transactions is active, that rules reflect internal investment guidelines and statutory requirements and that trade compliance alerts, overrides and exception reports are monitored, escalated and resolved timely.
• Confirm that pre-trade compliance controls enforce these requirements:
  • Block trades with counterparties not on approved counterparty list
  • Block repo trades exceeding maximum allowed tenor (e.g.>90 days)
  • Limit exposure to a single counterparty to less than 10% of total repo holdings
  • Restrict repo collateral to government or agency securities (e.g., AAA-rated only)
  • Enforce minimum haircut thresholds based on collateral type (e.g., 2% for UST, 5% for MBS)
• Confirm that post-trade compliance controls enforce these requirements:
  • Alert if repo concentration in any single issuer exceeds 25%
  • Flag if cumulative repo maturity profile exceeds 40% of short-term liquidity holdings
  • Monitor for settlement fails > T+1 and escalate to Treasury Operations
  • Report any exceptions to haircut thresholds and collateral eligibility
  • Compare counterparty risk ratings vs. internal credit score thresholds (e.g., BBB-floor)
• Review disclosures in annual comprehensive financial report (ACFR) or other official documents for accuracy and completeness
• Test compliance with liquidity and leverage thresholds under GASB and SEC guidance

10. Strategic portfolio

Use of repos to support leverage, duration targeting or yield enhancement may expose investors to unintended strategic risks.

Considerations

• Evaluate whether repo use is consistent with the organization’s strategic asset allocation and risk appetite
• Review performance attribution to assess whether repo financing adds value or introduces unacceptable risks
• Assess use of reverse repos and whether the strategy benefits outweigh liquidity constraints
• Assess the impact of hedging strategies using repos as a hedge for certain derivative exposures such as interest rate swaps

Key Trading Risks in To-Be-Announced (TBA) Pools

A TBA pool is a forward-looking MBS trade in which the seller agrees to deliver securities of a specific type, but the actual securities are not specified until shortly before settlement. TBA pools are typically used by institutional investors and traders to manage interest rate exposure and hedge MBS risks. Due to their structure, TBAs carry unique trading, operational and risk exposures.

1. Settlement and operations

Operational failures in trade execution, settlement or collateral management can result in financial loss or reputational damage. Due to the complexity of the TBA market, errors in booking, matching trades or managing positions can arise. TBA trades may also fail to settle due to lack of delivery, miscommunication with the counterparty, or failure to roll or pair-off correctly.

Considerations

• Review controls for confirming TBA trades on trade date (T+0) and monitoring settlement status
• Assess process to review and match TBA pool notifications 48 hours before settlement
• Test sample trades for timeliness and accuracy of pair-offs, rollovers and extensions
• Confirm trade account allocation data is communicated to custodian and allocated fairly across accounts (generally pro-rata based on net assets of the account, with documented permissible exceptions to this standard, such as limitations associated with bond lot sizes)
• Ensure trade fails are tracked, investigated and disclosed if material
• Confirm use of appropriate clearing mechanisms (e.g., Fixed Income Clearing Corporation or bilateral agreements under Master Securities Forward Transaction Agreements (MSFTAs))

2. Trade aggregation and allocation

TBAs traded in aggregate for multiple portfolios — such as trust, endowment and retirement funds — could be allocated incorrectly or unfairly, leading to performance, compliance or fiduciary breaches.

Considerations

• Assess the policy for trade aggregation and allocation, including method (e.g., pro-rata by net asset value or strategic need)
• Test allocation timing and audit trail; confirm that allocations are completed on trade date or no later than T+1
• Review system-generated versus manual allocations for accuracy and override controls
• Verify consistency of allocations with stated investment guidelines of each sub-portfolio

3. Counterparty credit

The counterparty in a TBA trade may fail to fulfill their obligation to deliver the specified securities at the agreed-upon settlement date, resulting in financial losses and operational disruptions. This risk is heightened in volatile markets.

Considerations

• Review counterparty due diligence (e.g., credit ratings, financials)
• Ensure all counterparties have executed MSFTAs
• Review credit reviews and exposure limits for all counterparties
• Test compliance with approved counterparty lists and exposure thresholds

4. Price transparency and best execution

Execution prices may not reflect best available pricing, because TBAs are traded over the counter.

Considerations

• Review how prices are validated or benchmarked (e.g., against Bloomberg screens or composite dealer quotes)
• Assess whether best execution policies are applied and documented
• Sample-check trade execution quality relative to market conditions at the time of trade

5. Interest rate and basis

TBAs are sensitive to interest rate and spread movements, which means that misalignment between hedges and actual exposures can cause unexpected losses. Rising rates decrease the price of MBS; falling rates increase the likelihood of prepayments, leading to reinvestment risk.

Considerations

• Review how interest rate exposure from TBAs is modeled in risk systems (e.g., duration, convexity)
• Assess how basis risk (between TBA price and actual pool pricing) is monitored and controlled
• Confirm that periodic back-testing or scenario analysis is conducted on interest rate and spread shocks

6. Collateral

One risk inherent to TBAs is that the value of the pledged collateral may decline, leading to insufficient coverage of the loan amount. This risk is particularly concerning if the collateral is not highly liquid or if its market value fluctuates significantly.

Considerations

• Evaluate haircuts applied and compare them to market norms and policy
• Test the timeliness and accuracy of daily mark-to-market collateral valuations
• Review margin call processes, including triggers, calculations and timeliness of responses
• Assess controls over collateral substitution and eligibility criteria
• Evaluate implementation of initial and variation margin requirements to ensure adequate collateral coverage throughout the life of the TBA and appropriate accounting of margin receivables and payables

7. Liquidity

While TBAs are generally liquid, the underlying MBS market can seize during times of stress, making it hard to roll or close positions. Certain TBA contracts (especially those with lower coupon rates or in off-the-run months) may have lower trading volumes. In addition, short positions may be harder to cover in volatile or dislocated markets, increasing the risk of forced buy-ins at unfavorable prices.

Considerations

• Evaluate monitoring of TBA roll activity and maturity ladders
• Review cash/liquidity forecasting models for inclusion of TBA settlement flows
• Review stress-testing or contingency plans for TBA liquidity freezes
• Verify that TBAs used for liquidity management do not create short-term funding mismatches

8. Dollar rolls and financing

Dollar roll strategies (selling a TBA and simultaneously buying a forward TBA for a later settlement) can behave like leveraged financing, introducing hidden risks.

Considerations

• Review the economic purpose and risk disclosure for dollar roll strategies
• Ensure roll transactions are entered into as a new forward contract
• Ensure dollar roll income is correctly calculated and reported as implied financing
• Confirm that risk oversight accounts for roll yield sensitivity to market factors (e.g., prepayments, Fed activity)

9. Prepayment and extension

Prepayment speeds directly affect the cash flow from MBS and are critical to assessing MBS risk. When mortgages underlying a TBA are prepaid faster (prepayment) or slower (extension) than expected, the cash flows and value of the MBS may be affected. If interest rates fall, prepayments may accelerate, reducing the yield. When rates rise, prepayments slow, and the average life of the MBS extends; investors may be stuck with lower-yielding securities while rates rise.

Considerations

• Ensure accuracy of prepayment models and active basis risk monitoring
• Confirm that risk oversight accounts for roll yield sensitivity to market factors (e.g., prepayments, Fed activity)

10. Valuation and mark-to-market

TBAs must be marked to market daily, but prices may lack precision, especially for longer maturities or off-market coupons.

Considerations:

• Risks can be managed with processes such as these:

• Assess whether independent third-party pricing sources are used (e.g., ICE, Bloomberg)
• Confirm pricing hierarchy (primary, secondary, manual override) and approval workflows
• Reconcile pricing across front-office, risk and accounting systems

11. Compliance

Externally, noncompliance with regulatory and legislative requirements can lead to fines, sanctions and reputational damage. Internally, TBA activity may inadvertently violate internal investment guidelines, especially those involving leverage, derivatives or asset-class exposure.

Considerations

• Review OMS pre-trade and post-trade compliance logic to ensure that compliance logic for TBA transactions is active, that rules reflect internal investment guidelines and statutory requirements, and that trade compliance alerts, overrides and exception reports are monitored, escalated and resolved timely
• Confirm that pre-trade compliance controls enforce these requirements:
  • Block trades with counterparties not on the approved list
  • Block trades outside permitted agency types (e.g., FNMA, FHLMC, GNMA only)
  • Warn if trade size exceeds position limits set by the investment policy statement or risk policy
  • Block trades with coupons or settlement dates not supported by the agency schedule
  • Flag if TBA notional exposure exceeds defined concentration thresholds by coupon or agency
• Confirm that post-trade compliance controls enforce these requirements:
  • Flag any TBA trade unmatched after T+1
  • Monitor for settlement failures or delays at DVP date
  • Alert if pool delivery details are not received within 48-hour window
  • Monitor net TBA exposure by agency and maturity and compare to IPS limits
  • Report pair-offs and dollar rolls separately for exposure transparency
• Review leverage and liquidity exposure limits, ensuring TBAs are correctly classified for compliance purposes
• Test whether trade strategy and execution support fiduciary standards of prudence and diversification; look for documentation of hedging objectives if a TBA short sale is used to offset exposure

Weaver Can Help

When assessing the risks and controls associated with your organization’s fixed income portfolio, organizations need to understand trading strategies beyond bonds and treasuries. Weaver recommends a review of holdings by type when planning begins so that you can shape your audit plan accordingly.

Weaver’s Asset Management Consulting practice supports risk, internal audit and compliance functions in navigating the complex investment risks presented by your portfolio. Contact us to discuss how we can help you manage risks and achieve your goals.

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