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Clearing Amp Settlement
US agency aims to grow tri-party clearing
From the Financial Times of Tue, 14 Oct 2014 22:40:06 GMT
A currency dealer monitors exchange rates in a dealing room at the Korea Exchange Bank in Seoul on May 18, 2012. Asian markets slumped and the euro fell further on May 18 as the eurozone debt crisis was stoked by a ratings downgrade for Greece and 16 Spanish banks, while weak US data added to the pessimism. AFP PHOTO / JUNG YEON-JE©AFP

The Fixed Income Clearing Corporation will announce on Wednesday it is seeking regulatory approval to expand its safeguarding of trades in a crucial $1.6tn segment of the financial system known as the tri-party repo market.

The move comes after regulators at the Federal Reserve expressed concerns about the repo market, where financial institutions from large banks to hedge funds pawn their assets in exchange for trillions of dollars worth of short-term financing.

The repo market is an important component of the shadow banking system and became Ground Zero for the 2008 financial crisis after creditors pulled back on their repo lending to broker-dealers including Lehman Brothers and Bear Stearns.

The abrupt withdrawal of repo funding constituted a run on these broker-dealers and alerted regulators to the vulnerability of other financial institutions that relied on short term loans to finance their assets.

Since then, Fed regulators have tried to reform the market by reducing reliance on repo and correcting perceived points of weakness in what has come to be known as the plumbing of the financial system.

In particular, the Fed has worked to reform the tri-party market that sees JPMorgan Chase and Bank of New York Mellon sit between many repo transactions. Despite that multiyear effort, regulators are still worried about the prospect of a “fire sale” of the collateral that secures tri-party repo loans.

The FICC, part of the Depository Trust and Clearing Corporation, clears tri-party and bilateral repo deals struck between banks and broker-dealers but wants to expand its tri-party service to include funds and other large investors.

Clearing trades is supposed to make the repo market safer by ensuring orderly liquidation of positions in the event of a bank or fund going under. Under the DTCC’s proposal, investment funds would become limited purpose members of the FICC and provide some interim liquidity in the event of a member’s default.

“Centralising the clearing and settlement of repo transactions through FICC could potentially help to prevent another squeeze in tri-party funding such as the one observed in 2008 when funds sharply reduced their lending during the run-up to the Lehman failure,” said Murray Pozmanter, managing director at the DTCC.

“It would also provide regulators with a broader and more comprehensive view of the repo market for the monitoring and management of systemic risk as well as mitigate risks associated with a fire sale in the tri-party marketplace.”

Despite the enormous size of the repo market, data on the complex web of transactions remains patchy at best especially for bilateral deals that are not cleared.

The FICC needs approval from the US Securities Exchange Commission and the Federal Reserve and expects to submit its proposal as soon as this month. The new service would cover almost three quarters of the $1.6tn tri-party market.

Other entities including CME Group and LCH.Clearnet are believed to be exploring expanded clearing services for some repo trades.

Such moves come at a time when banks have already been reducing their use of repo thanks to new capital requirements and rules that make it more expensive for them to arrange the transactions on behalf of their clients. The Fed has also taken over a sizeable chunk of the market thanks to its new reverse repo programme.

One repo market expert said: “Repo used to be something that banks made money off of, now the central counterparties will make money off of it and the Fed is just going to do more of it.”

Mr Pozmanter said that despite adding to repo transaction costs, the expanded FICC clearing service was likely to be received favourably by banks since it does not change the fundamental structure of a tri-party repo market that remains dominated by JPMorgan and BNYMellon.

“We’re not looking to change the market structure,” he said.

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