Is repo-ing out a bond the same as shorting the bond?

Question

In fixed income, or in any other products for that matter, borrowing an asset is essentially shorting the asset. As a result, you would see hard-to-borrow names where the borrow rates are much higher than normal repo rates.

I have recently heard some people mentioning the phrase "repo out a bond" interchangeably with shorting a bond, which I have a hard time wrapping my head around:

When you are repoing out a bond, I take it that you are a repo seller and you are borrowing cash and placing the bond as collateral, which you will buy back at a agreed price at the end of the contract. If you are buying the bond back at a pre-arranged price, it doesnt make sense that you will benefit from any decrease of MTM (unless a default happens during the repo period), thus you cannot possibly be shorting the bond and rather would be long throughout the entire contract.

Can anyone help point out what I am missing? Perhaps the person using the phrase is incorrect?

Also, if you have some insight into what exactly happens behind the scenes when a market-making desk at a bank "shorts" a bond, that would be great as well. The way I currently understand it is that the market-making desk would go the the repo desk and borrow the bond.

Answer 1

Repoing out a bond is not shorting the bond. Repoing out is essentially collateralized borrowing. One is selling the bond and agreeing to buy the bond back at an agreed upon price. The difference between the price at which they agreed to buy the bond back and the price that they sold the bond represents the interest (or cost) for them to borrow the amount that they sold the bond.

Bonds (and other assets) do go on "special". By this we mean that the costs to borrow become below market rates and can even go negative, where you will be paid to borrow the funds. Why this happens is because someone has an interest in shorting the asset. In order to short the asset, the shorting party must first secure the asset (locate) in order to sell it to someone. The shorting party borrows the asset, typically from a prime broker or custodian, and agrees to pay them fees and interest to borrow the asset. They are also agreeing to pay the positive return, if any, and dividends/interest. The prime broker/custodian/locate provider in turn pays the owner of the asset part of these costs the borrower (short seller) of the asset pays to short the asset. If the prime broker/custodian/locate provider doe not have the asset, they may induce the owner of the asset to repo the asset to them for a below market loan rate or pay them to repo the asset to them so that they can in turn lend it to the short seller. Finally, the short seller must purchase the asset in the open market to return it to the prime broker/custodian/locate provider, who will in turn sell the asset back to the original owner to close out the repo transaction.

As one can see, the repo transaction may be an important source to locate the asset for a short transaction but does not necessarily have to be. If the prime broker/custodian already has the asset because they are custodying the asset on behalf of a client, they can "lend" this asset to the short seller (provided they have an agreement with the custody client to do so, or is part of the custody agreement).