The tri-party repo market is making itself more resilient to the stresses like those which battered it during the financial crisis. 'Fire-sale' risk remains a critical policy concern of the Federal Reserve and other members of the U.S. regulatory community.
“The Fed considers this a very serious issue, and we certainly saw elements of it back during the Lehman failure,” Murray Pozmanter, head of clearing agency services at Depository Trust & Clearing Corp., told Markets Media. “You had multiple entities trying to liquidate trades into the same market, which certainly caused a lot of price dislocation and because there was no guarantor in place, you had a lot of tri-party lenders pulling away from the entire broker/dealer market in the run up the Lehman failure, which caused a liquidity squeeze.”
Murray Pozmanter, DTCC
The Federal Reserve said in a February 2014 progress report on tri-party repo reform that the risk of destabilizing fire sales of repo collateral by tri-party repo investors in the event of a default of a large tri-party repo borrower is not currently being addressed by industry participants.
DTCC subsidiary Fixed Income Clearing Corporation plans to provide central clearing for the over $1.6 trillion institutional tri-party repo market. The proposed service would allow the submission of institutional tri-party repo transactions between existing FICC sell-side customers and investment companies that are the cash lenders in the transactions.
“The key here is that we're attempting to address the fire sale risk that's in the market,” said Pozmanter. “We're attempting to reduce systemic risk by bringing the benefits of central clearing to this element of the market that hasn't had access to central clearing before. Since we're already a player in cleared tri-party, we're uniquely positioned to offer this service with very little change to the market structure.”
The risk of post-default fire sales is not unique to tri-party repo, but is a particular concern in the tri-party repo market given the composition of its investor base. Many tri-party repo investors are highly vulnerable to liquidity pressures and credit losses that may cause them to liquidate the collateral of a defaulted counterparty very quickly, even if they must do so at a loss.
Tri-party repo transactions are a type of repurchase agreement involving a third party--the–tri-party agent--which facilitates settlement between dealers (cash borrowers) and investors (cash lenders).
The tri-party agent maintains custody of the collateral securities, processes payment and delivery between the dealer and the investor and provides other services, including settlement of cash and securities, valuation of collateral, and optimization tools to allocate collateral.
In the United States, BNY Mellon and J.P, Morgan Chase—the custodial banks for tri-party repos—have re-engineered their tri-party repo settlement systems in ways that significantly reduce the amount of intraday credit needed for daily settlement, the Fed noted in its update.
Average tri-party repo balances at BNY Mellon were $2.1 trillion during the third quarter of 2014, up 6% from the year-earlier period.
“The technology expense that we have put into [tri-party repo] is largely behind us,” said Gerald Hassell, chairman and CEO of BNY Mellon, during the company’s third-quarter earnings call on Oct. 17. “We have a couple of more waves to complete but they’re really very technical in nature. It’s a global business for us not only in tri-party but collateral services broadly.”
Featured image via twixx/Dollar Photo Club
