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

ICMA, FSB, ISDA and Bloomberg are talking about the extension of the 48 hour rule in derivatives – where if a counterparty goes bust, liquidating the collateral is subject to a 48 hour stay – to securities financing trades (SFTs). We suspected all along that SFTs would be next on the list.

The issue first started in the swaps market. From a Bloomberg article, Banks Rewrite Contracts Worth Trillions to Shed Too-Big-to-Fail by Silla Brush and Jesse Hamilton, November 9, 2015:

“…Late last year, regulators and ISDA announced that swaps contracts worth trillions of dollars would be subject to a pause. That move, which applied to contracts that 18 banks have with each other, affected an estimated 90 percent of the swaps market. Under that agreement, lenders will wait as long as 48 hours before pulling collateral from failed lenders and canceling transactions…”

At the time this was first brought up, we wondered if 48 hours was really going to be enough time to do much of anything beyond get all your data together. If the purpose is to prevent fire sales by forcing a breather on all parties, in the model of receivership under OLA, it is not clear if this will do the trick. Back on October 4, 2012 we wrote in a post “What we can learn from Mike Tyson about OLA”

“…When thinking about how the FDIC’s Orderly Liquidation Authority (OLA) and Living Wills would really work,  I am reminded of the Mike Tyson quote “Everyone has a plan ’till they get punched in the mouth…”

What has changed? Not much, we suspect. Except the regulators are working to extend the stay to repo. Cash providers won’t be happy at all. Imagine a money market fund being told that they can’t liquidate their collateral from a failed counterparty for 2 days. Won’t that guarantee a run on that fund?

From the Bloomberg article:

“…According to materials from the meeting, lawyers said that while they are making progress, the goal is to also encourage bank clients to participate. Non-dealers are a major part of the securities financing market, representing trillions of dollars in trades, according to the notes…Hedge funds and other asset managers have been loath to sign up so far, arguing that the contract changes are restricting their rights and could threaten their clients’ investments. The Managed Funds Association, a lobbying group for hedge funds, published a paper in September that says bank regulators are requiring the changes without adequately discussing the policies with industry or the U.S. Congress…”

SFT has long depended on and jealously guarded the “safe harbor” allowing market participants to liquidate collateral, outside of bankruptcy stays. We are reminded of those who argued that extending those stays to MBS contributed to the financial crisis by virtue of banks relying on the ability to quickly liquidate collateral. It turned out a lot of that paper wasn’t so easy to sell and took many months to unwind.

Today the FSB distributed a press release “FSB welcomes extension of industry initiative to promote orderly cross-border resolution of G-SIBs” praising the acceptance of the effort. From the press release:

“…The Financial Stability Board (FSB) welcomes the announcement today by ISDA, SIFMA, ICMA and ISLA of the execution by 21 global systemically important banks (G-SIBs) of a revised ISDA Resolution Stay Protocol (the “Protocol”). The Protocol builds on the version developed in 2014, which focused on amending ISDA Master Agreements for over-the-counter (OTC) bilateral derivatives to improve the effectiveness of cross-border resolution actions. The coverage of the Protocol has now been extended to securities finance transaction master agreements…”


“…Today’s announcement marks a milestone, with the Protocol having been extended to cover securities financing agreements and an additional four G-SIBs having adhered to the revised Protocol…”

Toward the end of the press release was this:

“…As a result of the extension of the Protocol to securities financing transactions and its adoption by G-SIBs, it is estimated that more than $560bn of cross-border securities financing activity that could previously have been terminated at the point of resolution will be subject to the stay regimes of relevant G-SIB home jurisdictions…”

Is there a simple solution to this problem? Haircuts are calculated based on the expected time it will take to liquidate underlying collateral. Can’t cash lenders simply add 2 days to the unwind period and charge the cash borrower a higher haircut? That sounds reasonable, right? But the problem is in a high stress situation nasty enough to trigger defaults, the last thing you want to deal with is a stay, no matter how long. This could easily feed into a further bifurcation of the market – high quality liquid collateral versus everything else. Imagine having equities should you get hit with a stay? Those will be the longest two days ever.

The ICMA just formalized parts of this in ICMA Announces Publication of 2015 Universal Resolution Stay Protocol with Securities Financing Transaction Annex.

We have written about this issue before. Take a look at some of our earlier posts:

“Will automatic stays on securities financing trade defaults really help? We doubt it.”, (March 12, 2015)

“Will removing repo safe harbors fix systemic risk? This paper thinks so….” (August 28, 2014)

Regulators ask for ISDA to delay derivatives liquidations; is repo next? (November 11, 2013)

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2 Comments. Leave new

  • 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.

  • 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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