NEW YORK (MNI) – The following is the text of a statement Tuesday
by the New York Federal Reserve Bank following the release of the
Tri-Party Repo Infrastructure Reform Task Force’s report the status of
industry efforts to reform the tri-party repo market:
Earlier today, the Tri-Party Repo Infrastructure Reform Task Force
issued a report describing the status of industry efforts to reform the
tri-party repo market. While the Federal Reserve commends the Task Force
for its efforts to achieve systemic risk reduction in this market, much
work remains to be done.
The tri-party repo market is an important part of the U.S.
financial system. However, as observed during the recent financial
crisis, the tri-party repo market’s infrastructure exhibits significant
structural weaknesses that undermine market stability in a stressed
environment. The Federal Reserve was forced to take extraordinary policy
actions beginning in 2008 to counteract the effect of these flaws and
avert a collapse of confidence in this critical financing market. These
structural weaknesses are unacceptable and must be eliminated.
The Task Force was formed to develop options to address three
fundamental areas of concern identified by policymakers at the Federal
Reserve: (1) market participants’ overreliance on intraday credit from
tri-party clearing banks, (2) risk management practices that are
vulnerable to procyclical pressures, and (3) the absence of an effective
and transparent process for the orderly liquidation of a defaulted
broker-dealer’s collateral. The Task Force released a set of
recommendations in May 2010 to modify industry operations and practices
to sharply reduce the market’s dependency on intraday credit provided by
clearing banks. At that time, the Task Force indicated that the industry
would complete the recommended operational changes in 2011. This goal
was not achieved.
Based on the recommendations of the Task Force, market participants
have made a number of important changes to the tri-party repo settlement
process in the past year, all of which are prerequisites for reducing
market participants’ reliance on intraday credit provided by the two
tri-party repo clearing banks. Among these improvements are the
establishment of automated collateral substitution functionality for
most trades in the market and the implementation of a 3-way trade
confirmation process for all tri-party repo transactions. The Task Force
also improved transparency in the tri-party repo market by publishing a
monthly report on market size, collateral composition and margining
practices on its website. These accomplishments could not have been
realized without the concerted effort and dedication of the clearing
banks and the Fixed Income Clearing Corporation (FICC), as well as the
borrowers and lenders that actively participated in the Task Force.
Despite these accomplishments, the amount of intraday credit
provided by clearing banks has not yet been meaningfully reduced, and
therefore, the systemic risk associated with this market remains
unchanged.
When significant obstacles arose in the industry’s work last year,
senior executives from firms on the Task Force met to enumerate a shared
vision of the processes and practices needed to achieve the goal. Their
vision, outlined in the Task Force’s report, reflects lessons from the
2010-2011 implementation effort and input from the New York Fed
regarding the characteristics that a future settlement infrastructure
for tri-party repo must satisfy.
The clearing banks and FICC have submitted new plans and timelines
for the work needed to achieve this vision, and the New York Fed has
instructed them to begin work on refining and implementing the plans
immediately. As the Task Force’s report indicates, some systemic risk
reduction is likely to be achieved later this year with the elimination
of non-maturing trades from the daily unwind process by at least one
clearing bank. However, a multi-year effort will be required to achieve
all of the changes needed to realize the Task Force’s vision for the
entire tri-party repo market. The clearing banks and FICC are expected
to provide clear communication to the public on the timing of
deliverables in order to help ensure that all market participants have
adequate time to prepare for and adjust to the changes.
Given the expanded timeline for the industry’s work to reduce
reliance on intraday credit, and the fact that this work may not
substantially strengthen market participants’ credit and liquidity risk
management practices and mitigate the risk of fire sales of assets in
the event of a large dealer’s default, the Federal Reserve is making two
changes in its approach to tri-party repo reform going forward.
First, the New York Fed will intensify its direct oversight of the
infrastructure changes that the clearing banks and FICC are undertaking
in order to reduce market reliance on intraday credit. While the Task
Force has been an essential forum for generating and developing ideas,
it has not proved to be an effective mechanism for managing individual
firms’ implementation of process changes.
Second, the Federal Reserve is escalating its efforts to explore
additional policy options to address the remaining sources of
instability identified in the New York Fed’s May 2010 White Paper. The
Federal Reserve will pursue this work in parallel with the industry
efforts to reduce reliance on intraday credit and will consult with
other regulators and tri-party repo market participants as ideas are
further developed. Ideas that have surfaced and could be considered
include restrictions on the types of collateral that can be financed in
tri-party repo and the development of an industry-financed facility to
foster the orderly liquidation of collateral in the event of a dealer’s
default.
Ending tri-party repo market participants’ reliance on intraday
credit from the tri-party clearing banks remains a critical financial
stability policy goal. While the bulk of the work on operational changes
will fall to the clearing banks and Fixed Income Clearing Corporation
(FICC), borrowers and investors in the tri-party repo market will also
need to modify their credit and liquidity risk management practices to
realize the promise of these operational changes. As highlighted in the
Task Force’s May 2010 recommendations, dealers should be taking steps to
reduce their reliance on short-term financing and investors should be
taking actions to ensure their credit risk management policies and
practices are robust to stress events. Such actions can help to ensure
that market participants better internalize and price the costs
associated with the credit and liquidity risks they bear in tri-party
repo transactions. The Federal Reserve and other regulators will be
monitoring the actions of market participants to ensure that timely
action is being taken to reduce sources of instability in this market
** Market News International New York Newsroom: 212-669-6430 **
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