Funding Market That Sank Lehman Set for Central-Clearing Upgrade

  • DTCC’s interdealer platform to include cash lenders in 2Q plan
  • Influx of repo deals should reduce risk of debt fire sales

The Depository Trust and Clearing Corp., which processes securities transactions in the U.S., plans to expand central clearing of repurchase agreements in coming months to include cash lenders, in a move that may reduce risk in a key funding market for Treasuries trading.

The DTCC, through its Fixed Income Clearing Corp., expects to add cash providers such as asset managers to its central-clearing platform for the $1.7 trillion tri-party repo market. The venue, known as a CCP, now only backstops repo transactions between dealers, who often use the market to procure overnight funds.

The DTCC’s multi-year effort to broaden its repo central clearing dovetails with a Federal Reserve push to shore up the market, which almost collapsed amid the financial crisis, contributing to the downfall of Lehman Brothers Holdings Inc.

“FICC is rolling out, subject to regulatory approval, in the second quarter, two new products intended to bring buy-side participation,” Laura Klimpel, executive director of DTCC’s clearing agency services, said Tuesday at a conference in New York organized by consulting firm Finadium.

Fed’s Push

The Fed has been pushing the industry to follow up on steps it took to bolster the system, and central clearing is seen as the best way to reduce the risk that a dealer default could push counterparties to abruptly dump repo collateral. Such fire sales helped sink Lehman in 2008 and forced the Fed to step in to keep credit flowing.

The tri-party plan would expand FICC’s general-collateral finance clearing program between dealers to allow cash providers to be direct-limited members. In this new system, cash lenders can interact with a dealer or dealers of their choice. The collateral for the agreements would be restricted to Fed-eligible securities -- Treasuries and debt of federal agencies and government-sponsored enterprises. The DTCC will guarantee the transactions.  

Full members provide cash and assets to hold on reserve in case of a default. These new buy-side participants would provide FICC with a lien on the collateral in the deal. In the event of a default, FICC would foreclose on the lien to complete settlement with the dealer.

As more cash lenders join the program, the risk of fire sales should drop, Klimpel said. The cash providers must have a minimum of $100 million in assets to participate.

Dealer Outlet

Dealers finance more than $200 billion in securities daily through general-collateral finance repo, the only slice of the tri-party market that’s centrally cleared now. The Fixed Income Clearing Corp. serves as clearing agent for the agreements.

In a tri-party arrangement, a third entity, either Bank of New York Mellon or JPMorgan Chase & Co., acts as middleman to settle deals and safeguard collateral. JPMorgan has said it plans to exit government-securities settlement for dealers, including general-collateral finance repo.

The DTCC’s new tri-party program would apply to cash lenders that aren’t registered investment companies. The clearinghouse is working on a separate system for that group. It’s also seeking to expand a bilateral repo program that currently allows just registered investment companies to use the central-clearing platform through sponsored-member banks for overnight transactions. Subject to regulatory approval, the firm plans to allow qualified institutional buyer clients of sponsoring member banks to join.

We are providing these “models for people to choose from in terms of how they want to engage in the repo clearing with FICC,” Klimpel said.

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