What is a tri-party agreement?

How is a tri-party agreement explained? Also known as a tripartite agreement, it is a deal between three individual parties – typically a buyer, seller and bank or another lender.

Tri-party repurchase agreements, or tri-party repos, are a type of short-term investment used by managers of money market funds where a custodian bank or clearing organisation serves as a collateral agent and deals with the settlement and operation of the transaction.

Tri-party agreements are common on the mortgage market, particularly when a project is under construction and a developer needs to pre-sell the property to obtain financing.

Where might you have heard of tri-party agreements?

Money market use of repos and excessive lending on the mortgage markets – including tri-party agreements – were brought to widespread attention during the 2008 financial crisis, when they contributed to the downfall of financial institutions Countrywide Securities, Bear Stearns and Lehman Brothers. The use of tri-party agreements has declined since the crisis.

What do you need to know about tri-party agreements?

The US repo market is one of the most liquid sectors in the short-term credit market and is valued at around $1.6trn, according to US financial services company Wells Fargo. The figure is significantly down from $2.8trn, recorded before the 2008 financial crisis.

With a tri-party repo, the third-party lending agent prices the securities and holds the collateral in segregated accounts, protecting the buyer in case the seller goes bankrupt. Repos are effectively a form of loan – the securities are exchanged for cash and the seller agrees to repurchase them in the future.

The US Federal Reserve (Fed) purchases repos – including tri-party repos – as a way to provide cash liquidity for the financial markets during times of crisis. In March 2020, the central bank reintroduced its Primary Dealer Credit Facility, first introduced during the 2008 financial crisis, to support the economy during the Covid-19 pandemic. The Fed has also introduced measures to reform the tri-party repo market to shore up the banking system and avoid another crisis.

Tri-party mortgage agreements are commonly used during property construction, when buyers borrow financing from a lender to secure an agreement with the builder. The builder is included in the loan agreement as the buyer does not own the property until the completion of the sale when they take possession. In the property market, a tri-party agreement can also be used between the owner of a property project, a designer or architect, and a building contractor.

In the mortgage market, how a tri-party agreement works is that it sets out the terms of the loan including the value and interest rate, payment details, the stages of the property construction and the date the buyer will take ownership.

A tri-party agreement can also be used in a corporate debt situation, when a debtor agrees on financing terms with a third party, in order to pay a creditor.