Wednesday, November 6, 2013

Despite Reforms, Tri-Party Repo Remains a Fed Concern

New York Fed President Urges Industry to Present Solutions or Be Presented With Solutions


Author: David Schwartz J.D. CPA

In an October 14, 2013 address

, William C. Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, expressed some lingering concerns he and the Fed have about the tri-party repo market. Despite the reform efforts of both regulators and the tri-party repo industry, Mr. Dudley worries that tri-party repo still remains an area of significant systematic risk. In particular, he worries that current reforms do not address the risk that "a dealer's loss of access to tri-party repo funding could precipitate destabilizing asset fire sales, whether by the dealer itself, or by the dealer’s creditors following a default."  As we learned in 2008, these fire sales can have devastating and far reaching effects.

 

[W]hen fire sales occur they can undermine the stability of other markets beyond the tri-party repo market. The transmission of instability typically occurs as a consequence of increased margin calls and mark-to-market losses that strain firms’ liquidity and capital positions and put additional pressure on firms to further deleverage. Such scenarios can have material adverse repercussions on other market segments and market participants.

 

 

Since the collapse of Bear Stearns demonstrated the run risk that existed more broadly in the tri-party repo market, the tri-party repo industry has enacted myriad reforms. However, Mr. Dudley feels that industry participants have yet to fully embrace the role they must play in finding a solution to risk posed by "fire sales." As a result, he urged industry participants to begin work on this issue without further delay.  The wide range of participants in the industry, he says, has hindered the process. Dudley warned the industry to work together for a workable solution, or face the prospect of an imposed solution.
 

[T]he diversity of participants in the tri-party repo market has made it difficult to move forward quickly with a market solution that addresses the risk I have outlined. Industry leadership is absolutely critical to overcoming these challenges. If industry is unable to play its role in achieving a holistic solution, regulators may find themselves forced to employ the specific policy tools at their disposal in their respective purviews to address the fire sale risk. While such an approach may indeed enhance the overall stability of this market, it could also lead to unintended consequences that include reducing the efficacy of the critical role played by this market in supporting the broader financial system.

At the same event, Federal Reserve Board Governor Jeremy Stein suggested some of the solutions regulators may be forced to impose to reduce fire sale risk.  He posed for consideration capital surcharges, modifications to the liquidity regulation framework, and universal margin requirements.

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