Treasury Queries Bond Dealers on Changes to Repo Market Clearing

The U.S. Treasury is asking bond dealers to weigh in on potential changes to the way transactions are settled in the $1.6 trillion market for borrowing and lending securities.

The department is looking for insight into whether a move toward central clearing would help or harm the repurchase-agreement market, where the biggest banks post securities as collateral to meet their day-to-day funding needs. Central clearing reduces counter-party credit risk because clearing firms act as guarantors to all transactions and pool capital to use in the event of a member default.

The Federal Reserve has been seeking ways to strengthen the repurchase-agreement market since the the financial crisis, when the loss of repo financing contributed to the collapse of Lehman Brothers Holdings Inc. and Bear Stearns Cos. For the Treasury, dislocations in repo can cause traders’ funding costs to rise, making it more difficult to transact government securities.

“Repo central clearing is really the next big thing on the horizon,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., one of 22 primary dealers that are required to bid at government debt auctions. “Assuming central clearing does get implemented at some point, it should smooth market conditions and allow more players to be able to take the other side of trades.”

The query was included in a quarterly survey sent to all primary dealers.

Central Clearing

Clearinghouses including LCH.Clearnet LLC, CME Group Inc. and the Depository Trust & Clearing Corp. through its Fixed Income Clearing Corp. subsidiary, are among the companies working to develop repo clearing structures. FICC currently clears transactions between dealers in what is known as GCF repo.

Bank of New York Mellon Corp. and JPMorgan Chase & Co. serve as the clearing banks in what’s called the tri-party repo mark, currently the dominant system for repo clearing. In a tri-party arrangement, a third party -- one of the two clearing banks - functions as the agent for the transaction and holds the security as collateral. Treasuries and government-agency debt account for about 85 percent of the collateral posted daily in tri-party repo transactions.

The Treasury Department also asked dealers to discuss liquidity conditions in the Treasuries market, and also requested details on economic and fiscal forecasts for 2016 and 2017.

“From the Treasury’s perspective, this is really about creating a liquid market,” said Andrew Hollenhorst, a fixed-income strategist in New York at Citigroup Inc., a primary dealer. Some of the post-crisis regulations on banks “have made it difficult for dealers to operate a large repo business. And fixed-income markets in general, particularly the Treasury market, really depend on the repo market. It’s kind of the lubricant for all the trading that occurs.”

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