FSOC: more triparty protection needed
21 May 2014 New York
Image: Shutterstock
Additional steps may need to be taken to further increase triparty repo borrowers’ protection against funding runs in the broader context of liquidity regulation, according to the US Treasury’s Financial Stability Oversight Council (FSOC).
The FSOC, which is mandated to identify risks and respond to emerging threats to financial stability, said in its 2014 report that significant progress has been made over the past year in reducing market participants’ reliance on intraday credit from clearing banks.
Last year, the FSOC discovered that market participants relied heavily on intraday credit from clearing banks, and that there was weakness in their credit and liquidity risk management practices.
It also found that a mechanism for ensuring that triparty repo investors do not conduct disorderly, uncoordinated sales of their collateral immediately following a broker-dealer’s default did not exist.
The share of volume funded intraday by clearing banks fell from 92 percent in December 2012 to under 20 percent in December 2013, according to the FSOC’s 2014 report.
This is projected to fall below the Tri-Party Repo Infrastructure Reform Task Force’s goal of 10 percent by the end of 2014.
The task force was set up in 2009 at the request of the Federal Reserve Bank of New York to reform triparty repo. Representatives from J.P. Morgan and BNY Mellon, key clearing banks, are a part of the task force.
The Federal Reserve Bank of New York revealed in February that J.P. Morgan and BNY Mellon are providing more than a trillion dollars less in intraday credit to market participants on a daily basis than in February 2012.
“Both clearing banks have re-engineered the settlement process in ways that require much less intraday credit extension and have increased the price of credit they still provide. Market participants now face stronger incentives to manage their risk prudently; many dealers have extended the weighted-average maturity of their triparty repo funding thereby sharply reducing their rollover risk exposure.”
But the risk of collateral fire sales persists, argued the FSOC in its report.
“The risk of fire sales of collateral by creditors of a defaulted broker-dealer, many of whom may themselves be vulnerable to runs in a stress event, remains an important financial stability concern given the destabilising effect such sales may have on markets and their potential to transmit risk across a wide range of participants.
While regulatory reforms implemented since the financial crisis, such as increases in the amount of capital, liquidity, and margin changes for US broker-dealers, “may help to mitigate the risk of default”, the FSOC believes more can be done.
“The council advises all US regulators of firms that rely on this market for funding to assess whether additional steps may need to be taken to further increase triparty repo borrowers’ protection against funding runs in the broader context of liquidity regulation.”
“The council also urges coordination between market participants and financial regulators to address the risk of post-default fire sales of assets by triparty repo investors.”
General collateral finance repo activity, which settles on the triparty repo platform, is still relatively reliant on clearing bank intraday credit to facilitate settlement, the FSOC also found. It urged market participants to work to extend improvements in the triparty repo settlement process to general collateral finance repo settlement “as soon as possible”.
The FSOC, which is mandated to identify risks and respond to emerging threats to financial stability, said in its 2014 report that significant progress has been made over the past year in reducing market participants’ reliance on intraday credit from clearing banks.
Last year, the FSOC discovered that market participants relied heavily on intraday credit from clearing banks, and that there was weakness in their credit and liquidity risk management practices.
It also found that a mechanism for ensuring that triparty repo investors do not conduct disorderly, uncoordinated sales of their collateral immediately following a broker-dealer’s default did not exist.
The share of volume funded intraday by clearing banks fell from 92 percent in December 2012 to under 20 percent in December 2013, according to the FSOC’s 2014 report.
This is projected to fall below the Tri-Party Repo Infrastructure Reform Task Force’s goal of 10 percent by the end of 2014.
The task force was set up in 2009 at the request of the Federal Reserve Bank of New York to reform triparty repo. Representatives from J.P. Morgan and BNY Mellon, key clearing banks, are a part of the task force.
The Federal Reserve Bank of New York revealed in February that J.P. Morgan and BNY Mellon are providing more than a trillion dollars less in intraday credit to market participants on a daily basis than in February 2012.
“Both clearing banks have re-engineered the settlement process in ways that require much less intraday credit extension and have increased the price of credit they still provide. Market participants now face stronger incentives to manage their risk prudently; many dealers have extended the weighted-average maturity of their triparty repo funding thereby sharply reducing their rollover risk exposure.”
But the risk of collateral fire sales persists, argued the FSOC in its report.
“The risk of fire sales of collateral by creditors of a defaulted broker-dealer, many of whom may themselves be vulnerable to runs in a stress event, remains an important financial stability concern given the destabilising effect such sales may have on markets and their potential to transmit risk across a wide range of participants.
While regulatory reforms implemented since the financial crisis, such as increases in the amount of capital, liquidity, and margin changes for US broker-dealers, “may help to mitigate the risk of default”, the FSOC believes more can be done.
“The council advises all US regulators of firms that rely on this market for funding to assess whether additional steps may need to be taken to further increase triparty repo borrowers’ protection against funding runs in the broader context of liquidity regulation.”
“The council also urges coordination between market participants and financial regulators to address the risk of post-default fire sales of assets by triparty repo investors.”
General collateral finance repo activity, which settles on the triparty repo platform, is still relatively reliant on clearing bank intraday credit to facilitate settlement, the FSOC also found. It urged market participants to work to extend improvements in the triparty repo settlement process to general collateral finance repo settlement “as soon as possible”.
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