Is it a good idea for Circle to abandon US bonds and switch to repurchase agreements (Repo)?

The CEO of USDC issuer Circle, Jeremy Allaire, recently stated that they do not want to take on the risk in a scenario where the US government may not be able to meet its debt obligations. In response, Circle's affiliated global investment management giant BlackRock increased the Circle Reserve Fund's portfolio by $8.7 billion in overnight repurchase agreements.

What is a Repurchase Agreement (Repo)?

A repurchase agreement (Repo) is a short-term financing instrument commonly used between financial institutions. A repo involves two main steps: the seller sells securities to the buyer and agrees to buy back these securities at a specific price in the future.

The process is as follows:

1. At the beginning of the transaction, the seller (the party in need of short-term cash) sells securities to the buyer (the party willing to invest short-term) and receives cash from the buyer. These securities are typically high-quality, such as government bonds, and serve as collateral for the transaction.

2. After the agreement expires (which can be overnight or for a longer period), the seller buys back the securities from the buyer at a predetermined price (the original price plus interest).

In simple terms, a repurchase agreement means that I sell you an asset initially and buy it back at an agreed price (with interest) on the maturity date (Re-purchase).

However, in this case, the financing party (paying interest) becomes the Federal Reserve.

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Is Circle's Adoption of Repurchase Agreement (Repo) a Good Idea?

Circle lends idle funds to third parties, including major banks such as BNP Paribas, Goldman Sachs, Barclays, and Royal Bank of Canada. These banks lend the funds to the Federal Reserve, which uses government bonds as collateral. The next day, the Federal Reserve repurchases the government bonds with interest. Since Circle cannot directly participate in the repo market, it needs to go through third-party institutions, whose task is to manage collateral, assess collateral prices, and streamline the transaction process.

Originally, Circle held bonds that were about to mature in about 40 days. However, if the U.S. Congress fails to reach an agreement on raising the debt ceiling, there may be a risk of "delayed payment" for bonds maturing after June. Therefore, Circle invests these funds in the repo market through third-party institutions.

It is important to note that even if bonds maturing around June may face the risk of delayed payment, there is no credit risk (default). However, even so, Circle chooses to play it safe and invest in the repo market. The repo market usually settles overnight, and with the counterparty being the Federal Reserve, it avoids the risk of delayed payment.

Reflecting on the liquidity stress test caused by the collapse of Silicon Valley Bank at Circle