Bloomberg News

Fed Considers Policy Changes After Repo Reform Falls Short

February 17, 2012

(Adds comments from analyst in the fourth paragraph.)

Feb. 15 (Bloomberg) -- The Federal Reserve said it will increase oversight of reform efforts in the market for borrowing and lending securities and consider policy options after an industry group failed to meet goals for reducing risk.

Restrictions on the types of collateral that can be financed in the tri-party repo market and the development of an industry-financed facility to foster the orderly liquidation of collateral in the event of a dealer’s default are among the options being considered, according to a statement posted to the Federal Reserve Bank of New York’s website today.

The central bank is stepping up efforts after the private- sector Tri-Party Repo Infrastructure Task Force that was sponsored by the Fed in 2009 issued its final report today saying that more time and effort was needed to reach its primary goal of the “practical elimination” of the extension of intraday credit to dealers from industry’s two clearing banks. The Fed said the task force’s failure to meet that goal by the end of the fourth quarter leaves the infrastructure of the tri- party repo market with significant structural weakness that undermines market stability in a stressed environment.

“It is clear that the infrastructure that was developed over many years is really inadequate,” said Bruce Tuckman, director of financial markets research at the Center for Financial Stability in New York. “Whether the Fed is going to be able to succeed in pushing them any faster to implement changes isn’t clear.”

Bear Stearns, Lehman

The Fed has been seeking to strengthen the tri-party repurchase agreement which neared collapse in 2008 amid the demise of Bear Stearns Cos. and bankruptcy of Lehman Brothers Holdings Inc., and required central bank assistance during the financial crisis.

Fed Chairman Ben S. Bernanke in March 2009 called for an overhaul of U.S. financial regulations, including “enhancing the resilience of the tri-party repurchase agreement market.” “It may be worthwhile considering the costs and benefits of a central clearing system for this market, given the magnitude of exposures generated and the vital importance of the market for dealers and investors,” Bernanke said.

Repos are transactions used by the Fed’s primary dealers for short-term funding, and typically involve the sale of U.S. government securities in exchange for cash, with the debt held as collateral for the loan. Dealers agree to repurchase the securities at a later date, and cash is sent back to the lender. 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.

‘Target State’

“There was progress made and it’s good that the industry is still working to further reduce risks,” said Jeff Kidwell , a managing director of funding and direct repo at Boca Raton, Florida-based broker dealer AVM LP. “At this point, it is a positive that the Fed will now take a more active role.”

The Tri-Party Repo Infrastructure Reform Task Force outlined a “target state” for the industry and said further changes were needed to reduce risk in this primary dealer funding market, according to a note on the Fed’s website.

The “target state” that the task force described as necessary to insure that the market can function effectively and efficiently, includes that secured credit for the settlement of tri-party repo trades from clearing banks being capped at 10 percent of a dealer’s notional tri-party book, that non-maturing trades not be unwound, and agreed upon common set of rules to govern settlement prioritization.

Volume Declines

Over $2.8 trillion in securities were being financed on average daily during the market peak in 2008 through tri-party transactions, many of which had short-term maturities. During the first quarter of 2010, the value of securities financed by tri-party repo had fallen to an average of $1.7 trillion, according to New York Fed calculations of Bank of New York and JPMorgan data and presented in May 2010 Fed paper. In 2008, the largest dealer borrowing position exceeded $400 billion, and remains at more than $200 billion now, Fed researches noted in the research.

--Editors: Dave Liedtka, Greg Storey

To contact the reporter on this story: Liz Capo McCormick in New York at

To contact the editor responsible for this story: David Liedtka at

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