Xxxxxx’x Repo 105. The investment bank Xxxxxx Brothers devised a transaction structure, called repo 105, which it employed around financial disclosure dates for several years prior to its 2008 bankruptcy. The maneuver involved an arbitrage between US and UK accounting rules. Xxxxxx executed the repo transaction in the UK through an offshore subsidiary. The first leg was treated as a final sale under UK law. The reporting of the final sale was consolidated up to the US holding company balance sheet. With repo 105 Xxxxxx used its holdings of subprime mortgage securities as collateral and applied the proceeds of the first leg sale to pay down debt. This enabled Xxxxxx to simultaneously conceal its subprime exposure and to understate its indebtedness. Between the first-leg and the second-leg, Xxxxxx’x subprime securities were owned by its counterparty, so they were no longer recorded on Xxxxxx’x balance sheet during that time interval. Meanwhile, Xxxxxx received a payment of M at the first leg, which it used to pay down lines of credit. As a consequence, by timing repo 105 so that its quarterly release of financial information occurred between the first and second leg, Xxxxxx was able to report a balance sheet with a lower volume of subprime securities holdings and less debt than would be the case after the second leg (which it had a legal obligation to complete). It is estimated that, for several years prior to its bankruptcy, Xxxxxx’x use of repo 105 enabled it to under-report its holdings of subprime securities and its debt by approximately $50 billion.32 A.0.2 MF Global’s Repo-to-Maturity Program In a repo-to-maturity transaction, the lender collects the payoff from the security issuer on the maturity date. The borrower is only obligated to make a payment in the event the security issuer defaults on its obligation to repay. For two years prior to its 2011 bankruptcy, MF Global entered into repo-to-maturity transactions to conceal from investors and regulators its exposure to low-rated sovereign debt. An example of the strategy worked as follows. MF Global draws on a line of credit to purchase a risky high yielding Greek sovereign bond for a price of M . The purchase price of the bond is below its payoff at maturity, which is M +ξ (we normalize the interest rate to zero for simplicity). The discount on the purchase price is ξ. Shortly thereafter, MF Xxxxxx enters into a repo transaction in which is sells the Greek bond in the first leg for a price of M + 1 ξ and sets the s...
