Fails to Deliver and the Repo Fails Charge

In equities, failing to deliver a security you sold is a serious operational breach. In the Treasury market, it is routine and, crucially, was historically free: if a seller couldn't deliver a bond on the settlement date, the trade simply didn't settle that day and rolled forward to the next day at the identical price, with no penalty interest charged either way. That worked fine when short-term rates were comfortably positive. It broke down whenever rates fell near zero.

Why fails spiked when rates hit zero

Picture a seller who can't get their hands on a heavily squeezed, deep-special bond (see repo specialness) to deliver against a short sale. Normally, failing to deliver costs you the interest you would have earned holding cash instead of a fail — but if repo rates are already near zero, that opportunity cost disappears. Failing becomes a free option: you keep the short, wait for supply to loosen, and deliver whenever it's convenient, at no cost to you but at the cost of leaving your counterparty without the security they were owed. In 2008–09, Treasury settlement fails ballooned as a direct result of this zero-cost-to-fail problem cascading through the market — one dealer's fail causes the next dealer down the chain to fail too.

The fix: a penalty rate on fails

The Treasury Market Practices Group introduced a fails charge: a seller who fails to deliver pays a penalty rate to the buyer, calculated as $\max(0, 3\% - r)$ applied to the face value for each day of the fail, where $r$ is the prevailing benchmark repo rate. The 3% level was chosen deliberately high relative to typical rates, so that failing is never cheaper than sourcing the bond another way, even when rates are at zero.

Worked example

The general collateral repo rate is 0.25% and a dealer fails to deliver $20 million face value of a Treasury note for three days. The daily fails charge is $\max(0, 0.03 - 0.0025) \times 20{,}000{,}000 / 360 = 1{,}527.78$, i.e. $1,527.78 per day, or $4,583.33 over the three-day fail — a real, growing cost that gives the seller a clear incentive to source the bond and settle rather than let the fail run.