Repo Clearinghouse Adds Buy-Side in Move to Quash Systemic Risk

  • Firm talking with cash-lending investors seeking to join
  • Program that would bring in money-funds is still in the works

The only U.S. central clearinghouse for repurchase agreements is talking to dozens of investors interested in joining its new tri-party program, in a move that will bring cash lenders onto the platform for the first time.

Depository Trust & Clearing Corp. has a roster of cash providers, such as asset managers, who are seeking to participate after the U.S. Securities and Exchange Commission this month approved the DTCC’s plan to expand its central-clearing repo service to institutional investors. Previously, the DTCC only backstopped repos between dealers, who use the market to procure overnight funds by lending securities in exchange for cash.

The firm, which processes securities transactions in the U.S., is talking with cash providers and dealers that want to trade with them. It predicts the first transaction may take place in the second half of the year as it embarks on a venture that’s intended to safeguard a key funding market for Treasuries trading.

We are “ having a lot of discussions with a lot of people to help shepherd them through the process.” Laura Klimpel, executive director of DTCC’s clearing agency services, said in an interview at the firm’s Jersey City, New Jersey office. “Some were following the developments and then began to call us right after they heard we received regulatory approval.”

Fed Push

For more than five years, the Federal Reserve has pushed industry participants to take steps to extinguish systemic risk in the market, which seized up during the financial crisis and contributed to the downfall of Lehman Brothers Holdings Inc. The initiative also comes at a time when the repo business has become less attractive to banks because post-crisis regulations have increased their costs.

The industry has introduced some safeguards to the $1.7 trillion tri-party repo market, in which a third entity, typically Bank of New York Mellon, acts as middleman to settle deals and backstop collateral.

But the Fed’s view is that moving more transactions onto central clearinghouses could address the lingering risk of asset fire sales in times of market stress. Central counterparty clearinghouses backstop all deals, reducing the chance that repo counterparties would abruptly dump collateral.

A clearinghouse pools the resources of its members to ensure losses at one firm don’t harm all trading partners. Most over-the-counter interest-rate swaps contracts have moved to this model. The DTCC’s new cash lenders won’t have to post margin like dealers, although they may have to temporarily lock in repo deals with the clearinghouse if they have activity with a defaulting member. 

Buy-Side Welcome

DTCC’s initiative, through its Fixed Income Clearing Corp., breaks new ground by bringing buy-side participants into its tri-party repo central clearing.

Yet for some participants, the new arrangement still falls short because it doesn’t tap some of the primary lenders in repo -- asset managers from the $2.6 trillion money-fund industry. These companies face restrictions because they’re registered under the SEC’s Investment Company Act of 1940. They’re not included in the FICC’s new offering -- to be called the Centrally Cleared Institutional Triparty. The DTCC has been working since 2014 to bring these asset managers on board through a separate channel.

The registered money funds have about $858 billion in tri-party repo deals, according to Crane Data LLC.

“By excluding money-market funds, we believe this program is far from a panacea,” JPMorgan Chase & Co. strategists wrote in a note. “And owing to a range of concerns this aspect is unlikely to be resolved anytime soon.”

The expansion of clearing beyond dealers is still seen as reducing risk.

“Anything that moves the needle on more central clearing for repo is important,” said Tom Wipf, vice chairman of the institutional securities group at Morgan Stanley. “There is an increasing demand for high-quality collateral and a reduced capacity for intermediaries to move it through the system. Anything that we as an industry can do to unblock that, we want to do, and these steps by DTCC will create momentum in that process.”

A slew of asset managers will be able to join, including hedge funds, sovereign wealth funds, companies, pension funds and states and municipalities. DTCC is talking with officials from two U.S. states, Klimpel said.

“We are not finished both in terms of the different sectors of the buyside we plan to bring into our clearinghouse or the type of assets used as collateral,” she said.

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