The US Treasury’s Office of Financial Research (OFR) recently published its first annual report, including an interesting section on data transparency in the repo markets. The OFR was created as part of Dodd-Frank to promote analytics and critical thinking on financial markets – basically it is a think tank within the US Treasury. Beyond the regular platitudes on data integrity, here are three highlights that we think professionals in securities finance should note.
First, the repo breakout box on Page 124. The OFR is paying attention both to collateral and also to counterparty credit worthiness. We think this will wind up being a push towards CCPs in the US repo markets. The OFR is also talking about tri-party, bilateral and the DTCC’s General Collateral Finance markets. Our read into this is that regulators would like one market for analysis, or at least data that looks and is reported the same for all three markets. According to the annual report:
“Why did the apparent security of repo liabilities disappear? Were money market funds more likely than other repo lenders to pull their funds? As counterparties’ creditworthiness became more questionable, why didn’t repo lenders simply increase their required haircuts, to make the collateral provide more protection? Was this funding withdrawal preceded by other signs of tightening, such as a change in rates or haircuts? In general, should regulators view repo finance as equivalent to unsecured credit?”
“Following on the experience during the crisis, supervisors would like to understand the extent to which repo lenders rely on the borrower’s creditworthiness rather than on the value of collateral posted in the transaction. Understanding the repo market requires collection of transactions-level data about the repo market—information that is presently unavailable to regulators. Although the repo data collected by the Federal Reserve Bank of New York have improved considerably since the crisis, that data remain insufficient to understand when and how repo financing conditions are changing in ways that might affect financial stability (Adrian and others, 2012). Research needs to encompass all three repo markets: tri-party, Delivery versus Payment, and General Collateral Finance. The behavior of these markets differed starkly in the crisis.”
“The benefits of repo market analysis will accrue to both on-site supervisors and to those monitoring threats to the financial system more broadly. A more granular view of the repo markets would help improve macroprudential policy in three ways. First, it would provide information about the degree of stress in financial markets as a whole. Second, it would help inform policy—for example, there have been proposals to address the procyclicality in repo markets by introducing policies on haircuts, akin to the margin requirements that the Federal Reserve imposes under Regulation T in the stock market. Third, it would allow financial stability analysts to learn more about the mechanics of funding markets, such as the transfer of risk or trade segregation within prime brokerage transactions, and in the relationship between repo financing and securities lending (FSB and IMF, 2012).”
Second, the OFR is concerned with networks of trading parties – who is trading with whom and who gets impacted if one particular counterparty goes down. According to the annual report, “Network analysis can help uncover latent connections among market participants—who typically know their own exposures to counterparties but not the exposures of their counterparties to other counterparties—and foster understanding of how those interconnections can break down during a crisis.”
Third, securities finance participants can expect more seriousness from regulators on repo and securities lending data transparency. The report states “we will focus our near-term data efforts on understanding metrics for the sources of leverage, liquidity risk, and interconnections among financial firms—particularly as they emerge in the derivatives and shadow banking markets…. Failure to address data gaps in these areas is and will remain a threat to financial stability and a significant focus for the OFR and financial supervisors.”
The OFR seems to be shaping up to be an important source of data and analytics in financial markets, although it remains to be seen what kind of budget the new agency will receive. The finances of this new agency will in turn will affect its practical ability to carry out its mandate.
A link to the OFR’s 2012 annual report is here.