Extending the 48 hour collateral liquidation stay to financing trades: cash lenders won’t be happy

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  • A stay, however brief, dramatically alters the legal basis of repo transactions. Keep in mind two important characteristics of repos. First, their safe harbor status. Repo transactions are bankruptcy remote. Further, “events of default” which can trigger a liquidation can occur outside of a broader based adverse event. A repo default may not cause a broader based bankruptcy but the converse is not necessarily true. Second, repos represent the full title transfer of the security in question over the term of the transaction.

    Repo as it existed from the dawn of civilization; OK, from the 1930’s was used to fund highly liquid assets cheaply for brief periods of time. I would argue that a market that covers only US treasuries or possibly treasuries, agencies and agency MBS does not need a stay. Historically these were deep and liquid markets which could absorb substantial positions without dramatic movements in price. Two things have happened to change this: 1. Dealers have expanded the spectrum of assets funded on repo transactions to include various non liquid assets. 2. The wave of regulation which has attempted to remove risk from the market has in fact created volatility by reducing liquidity. Non liquid assets always posed a fire sale risk. Regulators’ actions have now added the possibility of a similar risk to the traditional market.

    Perhaps a better solution might have been to remove non liquid assets from the repo market. They currently make up 20.7% of the US tri party market, 12% if equities are excluded. But instead, ISDA has implemented a solution that strikes at the legal heart of the entire repo market. It has altered both the safe harbor status as well as the full title transfer of these transactions. Will it help avoid fire sales?…..Of course not. It will simply put the cash investor in a worse position when the two days have passed. During that time other parties are completely free to trade against the cash investor. The market will know that positions are coming to market. It will anticipate this event and adjust prices. This is clearly a rule that does nothing to foster a liquid financing market and everything to discourage cash investors to buy repo.

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  • It is time that the industry develops a new MRA agreement. For a long time the market used an essentially generic document. During the crisis many legal and credit departments developed language specific to the underlying details of each particular trade with some detailing pricing sources and procedures. It is clear that as the market evolved no substantial industry-wide rewrite of the MRA was done. It is time for the industry to develop a new legal document before regulators change the essence of this key document.

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