The NY Fed expects market participants in the tri-party repo market to reduce reliance on intraday credit and make risk management practices more resilient to a stress event in that market. In particular, broker-dealers and cash investors affiliated with bank holding companies and foreign banking organizations are expected to modify their business practices and processes in order to adapt effectively to the coming infrastructure changes. Broker-dealers are expected to reduce their reliance on short-term tri-party repo financing, particularly for less liquid assets, to achieve the necessary reductions in the usage of intraday clearing bank credit. Cash investors are expected to make their credit risk and collateral management practices more robust to stress events. While market participants are subject to the oversight of various regulators including the Fed and the SEC, the tri-party repo market is not regulated.
A repurchase agreement or repo is a sale of a security coupled with an agreement to repurchase the securities at a specified price at a later date. A tri-party repo is a repo transaction where a third party, the tri-party agent, provides operational services to the cash borrower and the cash lender. The tri-party repo market is important because it is a key source of funding for large securities dealers who depend on it for the bulk of their short-term funding. Cash investors, such as money market mutual funds, rely on the tri-party repo market to be a very safe, liquid short-term investment. The Fed believes that a disruption to this market would be disruptive to the broader financial system.
Over the course of the next several months, the Fed, working together with other regulators, will continue to closely monitor the actions of market participants and use all the supervisory tools at its disposal to encourage constructive and timely action to reduce sources of instability in the tri-party market.
All participants in the tri-party repo market are expected to provide for more timely and accurate trade confirmations. While clearing banks have implemented a three-way trade confirmation process as part of their 2011 reform efforts, many market participants continue to send late or inaccurate confirmations. Improving these practices is necessary to support a sharp reduction in intraday credit usage.
Both clearing banks and the largest broker-dealer affiliates of bank holding companies have been asked to submit execution plans and timelines. The clearing banks have already submitted their plans, noted the Fed, the largest broker-dealer affiliates of bank holding companies are now in the process of drafting plans that reflect how they will adapt to their clearing bank’s plans. The collective set of plans will be evaluated by regulators this fall.
Earlier this year, the Tri-Party Repo Infrastructure Reform Task Force issued its final report describing the status of industry efforts to reform the tri-party repo market. The Task Force indicated that additional time would be needed to reduce market reliance on intraday credit extensions by clearing banks to broker-dealers. Federal Reserve and SEC staff participated in meetings of the Task Force as observers and technical advisors.
The Task Force was formed to address potential systemic risk concerns associated with the infrastructure supporting the tri-party repo market. In particular, regulators are concerned with the market’s reliance on large amounts of intraday credit made available to cash borrowers by the clearing banks that provide the operational infrastructure for these transactions. Also, the risk management practices of cash lenders and clearing banks have been inadequate and prone to pro-cyclical pressures. In addition, there has been a lack of effective plans by market participants for managing the tri-party collateral of a large securities dealer in default without creating potentially destabilizing effects on the rest of the financial system.