Three years have passed since the Tri-party Repo Infrastructure Reform Task Force released its seven-point roadmap for reforms needed to (1) sharply reduce the market’s reliance on discretionary extensions of intraday credit by the clearing banks and (2) foster improvements in market participants’ liquidity and credit risk management practices.1
A great deal of progress has been made since the New York Fed’s last public statement in February 2014. Earlier this spring, Bank of New York Mellon completed the final piece of its new settlement process for triparty repo, achieving a number of reform goals and serving to bring all triparty repo trades into alignment with the roadmap originally laid out by the Industry Task Force back in 2012. As a result, the share of triparty repo volume that is financed with intraday credit from a clearing bank has dropped markedly, from 100 percent as recently as 2012, to a level averaging 3 to 5 percent today (as compared with the Task Force’s original target of no more than 10 percent). Clearing banks, dealers and investors all made changes to their practices and processes that helped to achieve this goal.
However, one remaining element of the Task Force’s reform roadmap, namely the full alignment of General Collateral Finance (GCF) repo settlement with the new triparty settlement process, is not yet complete. The settlement process for the majority of GCF repo trades that occur between dealers at the same clearing bank is largely aligned with the reform goals; minimal intraday credit is used, and settlement occurs between 3:30 pm and 5:15 pm. However, the subset of GCF repo transactions that occur between dealers at different clearing banks are still unwound at 8:30 am, and still require uncapped, discretionary extensions of intraday credit by the clearing banks to settle. This is a potential source of market instability in periods of stress. When triparty repo lenders reduce the provision of financing to a repo borrower, the borrower may seek to obtain funding in GCF repo, where trades are arranged anonymously by inter-dealer brokers. In a full-blown stress event, GCF repo usage, and the associated intraday credit needed to settle that GCF repo activity, could balloon suddenly and significantly, to levels that a clearing bank is unwilling or unable to support through the provision of the necessary intraday credit.
The New York Fed’s February 2014 statement noted that work to integrate GCF repo settlement into the new settlement process for triparty repo would not be completed until 2015. Unfortunately, the clearing banks and FICC have recently indicated that the work required to align settlement of these interbank GCF repo trades with the broader process will stretch beyond 2015, given the complexity of the reengineering challenge involved as well as the contention of this effort with other near-term changes that are required for other purposes. The New York Fed continues to work with the industry to push ahead on this last aspect of the industry’s reform efforts and to explore options to accelerate the successful completion of this last step.
A remaining policy concern of the New York Fed, which was not addressed by the Task Force’s roadmap for reform, is the risk of fire sales of collateral by a dealer that is losing access to repo financing (pre-default), or by creditors of a dealer once it has defaulted (post-default). Substantial progress has been observed to date with respect to pre-default fire sales, due to capital and liquidity regulations that have prompted dealers to extend the tenor of their financing for less liquid assets. But as yet, no mechanism exists to address the challenge of coordinating sales of collateral by the creditors of a defaulted dealer in an orderly manner. The New York Fed acknowledges current industry efforts to develop central clearing mechanisms for repo financing, which may offer opportunities to establish a process for orderly liquidation of assets of a defaulted member, which is a common feature of central counterparties in other markets.
1 The roadmap can be found on pages 2-3 of the Task Force’s final report.