The Wall Street Journal had some interesting comments today regarding a speech from Federal Reserve Bank of NY President William Dudley on tri-party repo reform. Apparently the Fed, which signed off on the tri-party repo reforms of from the Payments Risk Committee in May 2010, thinks that the implementation timetable is perhaps going too slow.
From the WSJ article:
Three years after the collapse of Lehman Brothers triggered a panicked credit crunch, changes aimed at bolstering safeguards in a key segment of the short-term lending market have fallen behind schedule, leaving the sector vulnerable to systemic risks at a sensitive time in world markets.
“Experience suggests that it is not easy for market participants to agree on measures that enhance financial stability when this goal conflicts with the commercial and business interests,” said Federal Reserve Bank of New York President William Dudley, a permanent voter on U.S. interest-rate policy, in a speech Friday. “If the private sector falls short in this instance, public authorities may need to intervene and impose more forceful regulatory solutions.”
The issue is in the unwind/rewind process. Finadium discussed this at some length in our July 2011 research report on the repo market:
An important mitigating factor in the concern about collateral is what has become known as the daily unwind/rewind. Early each morning tri-party clearing banks unwind their repo trades. Cash goes back to the cash lenders and the lien on the bonds in the broker/dealers’ box is released. Dealers can transact business and move their bonds around. Cash lenders can use the cash for redemptions, make cash market investments or roll over their tri-party repo for settlement later in the day. At the end of the day, rolled or new trades are put into place by the clearing bank – this is known as the rewind. Cash investors relied on the clearing banks to execute the morning unwind as a matter of standard operating procedure, when in fact it was dependent on the clearing bank believing the broker/dealer could roll their trades later in the day.
As data produced by the Fed do not suggest any major change in tri-party collateral holdings (except for an increase in CMO Private Label Investment Grade collateral over the historical average), the only other major flash point is the unwind/rewind process. The Fed appears concerned that even though the unwind/rewind process has been shortened, leaving clearing banks with less exposure than ever, there is still some slack in the system.
Of course, if the Fed is really concerned, they could always pull their NewBank plan out of mothballs and talk about a third US tri-party clearer…