Authors: Adam Copeland, Darrell Duffie, Antoine Martin, and Susan McLaughlin
During the 2007-09 financial crisis, it became apparent that weaknesses existed in the design of the U.S. tri-party repo market that could rapidly elevate and propagate systemic risk. This article describes key mechanics of the market, focusing on two that have contributed to its weaknesses and impacted market reform efforts: the collateral allocation and “unwind” processes. The authors explain that collateral allocation in the tri-party repo market involves considerable dealer intervention, which can slow settlement processing. The length of time required to allocate collateral has in fact been a significant obstacle to market reform. Another impediment to reform is the unwind process, or the settlement of expiring and continuing repos that occurs before new ones can be settled and continuing ones can be “rewound.” The intraday funding required as a result of the unwind process creates potentially perverse dynamics that increase market fragility and financial system risk. Indeed, a reengineering of the tri-party repo settlement process to be much less reliant on intraday credit is a main goal of current market reform. The authors argue that streamlining the collateral allocation process and eliminating the time gap associated with the unwind could minimize market risk and assist in the reform efforts.