Aug. 2 (Bloomberg) -- A Federal Reserve official told lawmakers the central bank will push to reduce risk in the $1.8 trillion repurchase-agreement market by pressing the largest dealers for faster and more accurate trade confirmations.
“Enhancing the market’s resiliency and its settlement system is an important regulatory and financial stability priority,” Matthew Eichner, deputy director of the Fed’s division of research and statistics, said today in prepared testimony to a Senate panel. “Supervisory efforts will yield substantial progress in eliminating the reliance of the tri-party repo market on intraday credit.”
Eichner said the Fed’s push to boost risk management in the tri-party repurchase agreement market, which neared collapse in 2008 amid the demise of Bear Stearns Cos. and bankruptcy of Lehman Brothers Holdings Inc., is taking longer than “many of us had hoped” because of delays in developing a plan to liquidate the collateral of a defaulting dealer.
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. and Bank of New York Mellon Corp. serve as the industry’s clearing banks. The market is the biggest single source of financing for U.S. primary dealers, the 21 firms that act as counterparties for the central bank.
“The reliance on discretionary intraday credit in the tri-party settlement process poses difficult dilemmas for cash lenders, borrowers, and clearing banks during periods of market stress,” Eichner told the Senate Banking Committee’s Subcommittee on Securities, Insurance, and Investment.
“As a result, securities dealers may experience a sudden and acute loss of funding,” Eichner said. “A clearing bank may be reluctant to unwind the tri-party trades of a securities dealer and extend credit if the bank perceives a material risk to the financial viability of the dealer.”
Repos are transactions used predominantly by the Fed’s primary dealers for short-term funding, and typically involve the sale of U.S. government securities in exchange for cash, generally lent by money market mutual funds. The debt is held as collateral for the loan. Dealers agree to repurchase the securities at a later date, and cash is sent back to the lender.
The Fed took over efforts to improve functioning of the tri-party repo market in February after the private-sector Tri-Party Repo Infrastructure Task Force, sponsored by the Federal Reserve Bank of New York, disbanded. The Fed said July 18 that banks should rely less on intra-day credit from clearing banks and enhance risk management.
The repo task force said in February that more time and effort was needed to reach its goal of the “practical elimination” of the extension of intraday credit to dealers from the industry’s two clearing banks.
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