By Yali N’Diaye

WASHINGTON (MNI) – The private industry’s initiatives to strengthen
the resilience of the tri-party repo market and improve its settlement
system have yielded some results, but U.S. lawmakers Thursday questioned
whether the rate of progress was too slow, and if the government’s
involvement in the process should be increased.

During a Senate Banking subcommittee hearing on the remaining
challenges facing the $1.8 trillion tri-party repo market, Sen. Jack
Reed, the chairman of the subcommittee, also asked for clarification
about which regulator was responsible for successfully completing the
reform of the market.

That question was directly addressed to Matthew Eichner, Deputy
director of the Federal Reserve’s Division of Research & Statistics,
testifying before the subcommittee on Securities, Insurance, and
Investment.

In its annual report, the Financial Stability Oversight Council —
which includes the Fed and the Securities and Exchange Commission among
its member agencies — cited remaining vulnerabilities in the tri-party
repo market.

“Limited progress has been made in substantially reducing the
reliance of this market on intraday credits or improving risk-management
and collateral practices to avoid fire sales in the event of a large
dealer default,” the report said.

So far, the initiatives have been conducted by the private
industry, with the assistance of the New York Fed, leading Reed to ask:
“Who is really in charge?”

He asked whether the New York Fed has the responsibility or the
authority “to step in and be the involved government party.”

“Or is it the Board of Governors, or is it the SEC, or is it lots
of people” with the implication that “everybody is involved but no one
is in charge.”

Eichner said that the initial hope was to “find an industry
solution,” which led to the creation of a Tri-Party Repo Infrastructure
Task Force in September 2009 at the request of the New York Fed.

“Substantial progress was made through that process,” Eichner said.
However, “we did not get to the end of the road.”

Today, for instance, while the daily unwind occurs later than it
did a few years ago, “essentially all of the $1.8 trillion tri-party
market is still unwound every day,” he said, referring to the settlement
process: dealers access the securities they had posted as collateral so
they can be delivered to the buyers. The clearing bank then typically
provides funding for the collateral by extending credit to dealers,
while investors receive their cash.

“Under this settlement process, almost all trades are unwound each
day whether the trades are maturing or have remaining terms,” Eichner
explained. “Thus, almost the entire value of this market is funded each
day through the extension of intraday credit by a clearing bank.”

A characteristic that is concerning regulators.

In response, “We began with an industry process,” thinking the
industry was best positioned to know what the best solutions would be,”
Eichner said.

But “when it became clear in the middle of 2011 that the tri-party
task force was not going to meet its public commitment from 2010″ to
virtually eliminate intraday credit by the end of 2011, the Fed
increased its involvement, he continued. In particular, he said, “it
“brought supervisory tools,” notably a reform plan announced on July 18
by the New York Fed.

That left Reed unsatisfied.

“Who is the person who’s got the permission” to bring the process
initiated by the private sector to a conclusion, the senator insisted.

Is it New York Fed Chairman William Dudley, or is it Fed Chairman
Ben Bernanke, or is it SEC Chairman Mary Schapiro, he asked. “Do you
have an answer?”

“All of the above,” was Eichner’s first answer.

That being said, Eichner added, the FSOC “does have, I think, a
clear statutory responsibility to deal with situations” such as this
one.

That left Reed just as unsatisfied, given the number of agencies
that are part of the FSOC.

“We need a specific answer,” Reed said, “because we don’t want to
be in a situation again where everybody is involved but no one’s
responsible,” he said.

Reed urged clarification on “the notion of who is in charge here
from the federal prospective.” He said the Senate Committee will “follow
up.”

Besides clarification on the responsibility for completing the
reform, lawmakers also expressed concern at the pace of the reform.

The New York Fed’s reform plan announced in July requested among
others that clearing banks “introduce changes to their technology,
policies and procedures in order to achieve a more resilient
infrastructure for the tri-party market.”

In a tri-party repo, a custodian bank or a clearing bank plays an
intermediary role between the two parties — the seller of the
securities and the buyer of the securities.

Representing this side of the transaction at the hearing was
tri-party agent BNY Mellon, which has 80% of the market share, according
to Vice Chairman Karen Peetz.

BNY Mellon is “identifying asset classes eligible for intraday
credit associated with tri-party repo transactions and we are working
with our clients to eliminate intraday credit associated with less
liquid forms of collateral,” Peetz said. “We expect these measures to
reduce intraday exposures by $230 billion by early next year.”

She added, “We are developing the technology for a systematic
approach to reforming the entire unwind process that will practically
eliminate exposures by the end of 2014,” Peetz told lawmakers, compared
with an initial target date in 2016.

Still, asked Reed, with the possibility of another financial
crisis, “is 2014 too long?”

“It remains a real concern,” Eichner said. However, while it is
important to move in a deliberate, it should not be a disruptive
process.

Eichner added he was comfortable with 2014 as the Fed asked market
participants for “very detailed timelines.”

A fire sale and possible domino effects could be the trigger for a
crisis, lawmakers stressed, hence the need to address this issue
specifically.

“We remain very concern about that collateral liquidation problem,”
Eichner said.

“Even once the issue of intraday credit issue has been addressed,”
Eichner said, “there is still more to do around collateral liquidation.”

In his prepared testimony, Eichner said, “A significant remaining
challenge, however, is the development of a process to liquidate in an
orderly fashion the collateral of a defaulting dealer that would operate
reliably in the context of a settlement system organized around clearing
banks.”

He then said during the question and answer session that “We are
hopeful at the Federal reserve” that the industry will develop a
consensus “over time” that can then be “root to a solution.”

From the investor’s side, State Street Global Advisors Executive
Vice President Steven Meier suggested the Fed start auditing “default
contingency plans.”

The Fed would “make sure that people have a thoughtful process in
terms of what they are accepting as collateral and that they are
actually looking at it.”

** MNI Washington Bureau: 202-371-2121 **

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