Update on US tri-party repo: looking pretty good but still some potential hiccups

Earlier this month there was a conference sponsored by SIFMA on US tri-party repo. It was an excellent view on what has been done to strengthen tri-party and a little bit about what is to come. A link to the presentation is here.

The participants were

  • Ed Corral, Morgan Stanley
  • Vic Chakrian, NY Fed
  • Michael Katz, JP Morgan Chase
  • Helen Lloyd-Davies, Fidelity
  • John Morik, BNY Mellon
  • Murray Pozmanter, DTCC

The progress has been pretty impressive. Intra-day credit usage created by morning unwinds and evening rewinds – which the regulators have flagged as a source of systemic risk – have been taken down to 5%.

Intraday Credit Use JPEG

One driver of this has been been changing the way maturing trades that are rolled into new deals are handled. Those trades won’t unwind/rewind, hence no extension of credit by the clearing banks. But there is a technical glitch: the key is notification before 3:30pm. This is a tough ask given that so much investor activity isn’t booked until after 5:15pm. The Fed also wrote about this in their October 20, 2014 Liberty Street Economics blog post “Don’t Be Late! The Importance of Timely Settlement of Tri-Party Repo Contracts”. Changing those habits will require compressing the money fund’s day and changing procedures. The Fed writing posts and market saying “pretty please” may not prove persuasive enough. Here’s a chart from the SIFMA presentation showing when investors currently fund their repo trades.

TR Timing JPEG

The meeting also addressed the new DTCC initiative to centrally clear repo. This is big news. Adding a membership category for Registered Investment Companies (RICs) that won’t be subject to mutualization can provide a private parallel to the Fed’s RRP program. Clearing via a CCP is seen as less risky than bilateral trading, although not everyone is thrilled at the prospect. Higher credit quality dealers can look at this as diluting their franchise vis-à-vis their competitors. But we wonder if increased (balance sheet) netting opportunities may trump other issues.

The idea is that RICs will have the same exposure as if they had done the trade on a bilateral basis (e.g. no other customer risk). But the devil will be in details and we’ve already heard some rumbling about how margin will be calculated and held. We will be sure to get into this further in other posts.

One issue that seems to still be floating around tri-party is the impact of GCF repo on the extension of credit to FICC when movements are interbank (e.g. across clearers). The Fed looked at this in “A Primer on the GCF Repo® Service” (Staff Report No. 671, April 2014, Revised May 2014). They wrote:

“…For the interbank case, clearing banks extend credit to FICC to unwind all interbank GCF Repo positions. The proposed settlement change outlined earlier does not address this basic issue. There are two unusual aspects to this intraday credit extension to FICC. First, the amount of the credit necessary to unwind these transactions is equal to the total net amount of interbank GCF Repo, which can be quite large. In recent history, this amount has been quite variable and occasionally reaches the tens of billions of dollars. Second, the amount of credit extended to FICC is not a result of FICC’s actions, but rather of dealers’ trading. Consequently, any restrictions on the amount of credit extended to FICC could only be enforced if constraints are placed on dealers’ trading behavior. How the clearing banks will handle the intraday credit extensions to FICC to settle interbank GCF Repo trades has not been determined…”

We’re at the point now where banks and the buy-side are adjusting to regulations, not just fighting them. The US tri-party space is a great example of how change is actually happening.

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