Bond Clearinghouse Set to Seek Expanded Tri-Party Repo Role

The Depository Trust and Clearing Corp. plans to seek regulatory approval to provide central clearing for government-related securities to contain risks in the $1.6 trillion-a-day tri-party repurchase agreement market.

The clearinghouse aims to reduce the risk of rapid asset sales of securities held by cash lenders upon the default of a dealer, which could escalate a market crisis by triggering a broad-based decline in asset prices. The Federal Reserve has identified this issue as the primary remaining risk in this wholesale funding market that Wall Street’s biggest banks rely on for their day-to-day financing needs.

“Central clearing goes a long way toward eliminating the fire-sale risk that currently exists in the tri-party repo market,” Murray Pozmanter, managing director and head of clearing agency services in New York at DTCC, said yesterday in a telephone interview. “This would take a lot of the uncertainty out of how a dealer default would be handled.”

The New York-based DTCC announced in a statement it will propose rule changes to the Securities and Exchange Commission and the Fed. The clearing would be handled through the Fixed Income Clearing Corp., a DTCC subsidiary.

Repo Parties

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 DTCC would extend limited memberships to investment companies, which provide cash to participants in exchange for debt collateral in the tri-party repo market, for transaction using government-related securities. The FICC clears this type of tri-party repos between the Fed’s 22 primary dealers. If the rules are implemented, the FICC would clear about 74 percent of the daily tri-party repo activity, according to the DTCC statement.

Given that the primary risk of repo fire sales, as was exemplified during the financial crisis, was with equity, corporate and private-label mortgages securities, the DTCC plans won’t resolve the key remaining concern of the Fed, according to Scott Skyrm, author of the book “Rogue Traders” who also runs a blog on the repo market.

“The DTCC’s proposals are following the direction the market into going in the future, toward central clearing,” Skyrm said in a telephone interview. “But is it a lightning bolt of transformation and cleaning up the market? Definitely not.”

Financial Crisis

Since the 2008 financial crisis, the Fed has tried to strengthen the tri-party repo market, which nearly collapsed amid the demise of Bear Stearns Cos. and bankruptcy of Lehman Brothers Holdings Inc. The central bank created liquidity mechanisms to prevent fire sales and support its primary dealers in 2008. Fed officials backstopped the market through the Term Securities Lending Facility, for loans of Treasuries to Wall Street dealers, and the Primary Dealer Credit Facility for cash loans to the firms.

The Fed took over efforts to improve functioning of the market in 2012 after the private-sector task force it sponsored disbanded. In February, the New York Fed pushed the industry to take more action, saying fire sales risk “is not currently being addressed.”

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