We want to thank our friends who came to the Finadium Repo Panel and Networking Event in New York on Tuesday. It was a great panel discussion and featured lively discussion on the current state of the U.S. Government and Agency repo market, Emerging Markets repo, Tri-Party, and more. And the drinks, hors d’oeuvres, and networking afterwards were a lot of fun, compliments of our sponsors SunGard and JP Morgan.
There was one issue that was flagged and probably could use some additional exposure: Basel III, repo and bankruptcy.
The gist of the matter was that Basel III is saying that in order to get preferential capital treatment on a repo, the counterparty must be subject to the uniform bankruptcy code. The list of those outside the bankruptcy code was scary: ERISA clients, sovereigns, and supra-nationals just to mention a few. Anyone who doesn’t necessarily go through normal bankruptcy channels. The fear is that those clients will be locked out of repo without some relief on this measure. Clearly an unintended consequence of what seemed like a good idea at the time. We hope this issue pops up around more conference tables. This is a really big deal and will be doing some research of our own, no doubt.
A related issue came up on bankruptcy stays and tri-party. We have read where some Fed (and former) officials have been taking about using stays to slow down fire sales. Current bankruptcy law (and we are, by the way, not lawyers so take it as such) says the non-defaulting party can liquidate collateral when there is a default. This goes back to the days of Drysdale and Lombard Wall and the laws created in the wake of those debacles. Originally the laws covered primarily US Treasuries and Agencies, but later expanded to other securities and pretty much anything that was called a “qualified financial contract”. It is part of the foundation of modern repo: if your counterparty goes bust, you can sell without being hampered by a court stay.
By allowing stays, it can prevent fire sales. The whole process slows down. Now one person’s fire sale is another’s “liquidate before it gets worse”. But if markets are mean reverting, creating some space between the default and selling could act like a circuit breaker on the equities market and help restore order. We think this might be a bridge too far and the knock-on effects from such a change to the bankruptcy codes (like massively higher haircut on anything with less liquidity than a U.S. Govie) will be a non-starter. The recent Fed paper “The Risk of Fire Sales in the Tri-Party Repo Market “ addressed this in the context of tri-party and sends a clear signal that the Fed is not done yet with repo. We will say it again: read this paper. Quiz to follow.
Again, thanks to everyone who came, especially our esteemed panelists and generous sponsors.
A link to the Repo Panel and Networking Event agenda is here.
A link to the FRBNY paper is here.