FSOC report targets non-bank financial institutions in US repo

US Financial Stability Oversight Council 2020 Annual Report

The short-term funding market provides essential funding to businesses, local governments, and other financial intermediaries and can have implications for financial stability and the implementation of monetary policy. Recent events, including the financial fallout from the pandemic, have confirmed that potentially significant structural vulnerabilities remain in STFMs.

Money market funds (MMFs) offer shareholders redemptions on a daily basis while holding many short-term assets that are less liquid, especially in times of stress. Stresses on prime and tax-exempt money funds in March revealed continued structural vulnerabilities, which led to increased redemptions and, in turn, likely contributed to the stress in STFMs. Among institutional and retail prime MMFs, outflows as a percentage of fund assets exceeded that of the September 2008 crisis. Outflows abated after the Federal Reserve announced support for the CP market and MMFs.

Liquidity demand from leveraged participants, such as hedge funds using Treasury collateral and mortgage real estate investment trusts (mREITs) using agency MBS collateral, may have also played a significant role in the recent market volatility. Some of these leveraged participants are vulnerable to funding risks because of their reliance on funding in repurchase agreement (repo) markets. When such leveraged participants face margin calls (either because of an external shock to the repo market or investor concerns about their profitability), it creates incentives for them to deleverage. Since the assets on their balance sheets are the same assets used as collateral in their repo funding, the need to deleverage can increase selling pressures and lead to more margin calls. The complexity of interactions involving leveraged participants raises concerns as to their role in amplifying funding stresses.

The Council recommends that regulators review these structural vulnerabilities, including the vulnerability of large-scale redemptions in prime and tax-exempt MMFs, and the role leveraged nonbank entities may have played in the repo market. The Council also recommends that, if warranted, regulators take appropriate measures to mitigate these vulnerabilities.

Related Posts

Previous Post
Get the weekly SFM update – our December 4 newsletter is online
Next Post
AFX starts executing AMERIBOR interest rate swaps

Related Posts

Fill out this field
Fill out this field
Please enter a valid email address.

Menu
X

Reset password

Create an account