The contraction in the U.S. market for borrowing and lending securities amid rising interest rates and heightened global bank regulation will increase this year, according to Fitch Ratings.
The U.S. tri-party repurchase agreement market contracted $257 billion, or 14 percent, in 2013 to $1.61 trillion as of the end of 2013, according to Federal Reserve data, Fitch wrote in a report published today. A 28 percent decline in repos using agency mortgage-backed securities led the fall, while usage of Treasuries as collateral for the transactions also dropped, contracting 10 percent.
“The interest rate sensitivity of collateral means agency MBS and Treasury repos were more affected as rates started to rise in May 2013 on expectation of taper” of bond purchases by the Fed, the Fitch report said. “Tougher financial market regulations and deleveraging in the financial sector as institutions adjust to Basel III rules being phased in from 2014, have also hit US Tri-party repo volumes,” authors Martin Hansen and Cynthia Chan of Fitch, wrote in the note.
Capital and liquidity rules for banks, known as Basel III, were enacted by international regulators in 2010 in a move to help protect the world’s economy after the worst worldwide financial crisis in decades following the collapse of the U.S. subprime mortgage market. The U.S. Dodd-Frank Act, which includes the Volcker rule which seeks to curtail proprietary trading by banks, has added additional requirement to banks also working to meet Basel III regulations.
“Regulatory constraints on banks’ trading activities, including the Volcker Rule and more conservative Basel 2.5 market-risk capital charges, may reduce their repo funding needs and their repo intermediation services,” the Fitch authors wrote.
Repos are transactions used by the Fed’s primary dealers for short-term funding, with money-market mutual funds typically the cash providers. They typically involve the sale of U.S. government securities in exchange for cash, with the debt held as collateral for the loan. Dealers agree to repurchase the securities at a later date, and cash is sent back to lenders, which often are money funds.
The Fed has been seeking to strengthen the tri-party repo market, which approached collapse in 2008 as Lehman Brothers Holdings Inc. went bankrupt. The central bank intensified its effort after a private-sector Tri-Party Repo Infrastructure Reform Task Force that it sponsored issued a final report in February that said more time and effort were needed.
In a tri-party arrangement, a third party, one of two clearing banks, functions as the agent for the transaction and holds the security as collateral. JPMorgan Chase & Co. (JPM) and Bank of New York Mellon Corp. (BK) serve as the industry’s clearing banks.
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