Thank you to everyone at the Finadium Conference on Tuesday, March 25th. It was a great success with a record-breaking turnout. We would like to do a post on a couple interesting things we heard.
Central Counterparties for Repo and Sec Lending:
While this is a topic that has been discussed ad nauseam in many forums, there was a distinct change in this go round. Usually the debate focuses on issues like how both sides putting up margin won’t work and why adoption of CCPs on trades outside of the inter-dealer market isn’t feasible. But we didn’t hear that. It was more like “regulators will force us to use central clearing, they don’t care about the cost. It will come.” And “CCPs are the right direction to take.” We are not sure everyone was enthusiastic, but there was a consensus.
One interesting comment was “CCPs bring everyone to average”. This is true in the sense that higher rated players, who could extract better terms by virtue of being a more coveted counterparty, lose that advantage when clearing through CCPs. But in the world of banking, just like in Lake Wobegon, everyone is above average. And CCPs dilute that.
Collateral Shortages:
We got a preview of an upcoming ECB study on collateral shortages. There is $40 trillion of HQLA in the world versus collateral needs of $3 ~ $4 trillion. There isn’t a shortage, just a dislocation and an unwillingness to pay the price to dislodge stubborn paper.
Foreign Banks and new US Capital requirements:
Lots of pessimism here surrounding the proposed capital rules for foreign banks. Given the new regs, it was argued that maintaining a matched (repo) book would be very difficult. It was noted that 10 of the 15 primary dealers are foreign and should those dealers shrink considerably (as one or two have already started to do in earnest), there will be a considerable negative impact on liquidity.
Fannie and Freddie:
The question was asked: if the proposed plan to re-invent Fannie and Freddie goes through, will it mean their paper will no longer trade in the traditional high quality repo markets? Will repo markets for that paper look more like those for lower quality and less liquid markets? Given the size of Fannie and Freddie paper outstanding and the role it plays in HQLA repo markets, this was seen as a problem with potentially enormous negative consequences.
Fire sale risk and less liquid assets in the repo market
While not necessarily new, it is worth noting that there was discussion on the lack of resolution of fire sale risk for the 20% of the tri-party market that is not HQLA. We have written before about how it is that part of the market that actually needs some help. Post-Lehman you could sell Treasuries but the same could not be said of corporate bonds. There was no clear consensus on what the best direction to go is – a liquidation agent, higher haircuts, extra capital for repo businesses have all been thrown out there – but what we heard was an expectation that something needed to happen.
On how to fund less liquid assets:
We heard that the pressure to term fund non-HQLA as well as some of the potential knock-on effects of rules to control fire sales could mean that illiquid paper will be funded using unsecured cash. We know from experience that access to unsecured cash is guarded jealously by Bank Treasury Departments and, when available, is very expensive. One panelist noted that ultimately those higher costs will flow back to raise the expense of leverage embedded in pension plans, insurance companies, and the like, making it harder for them to meet their obligations.