The $1.6 trillion tri-party repurchase agreement market could get a central clearing repository if one clearing agency has its way.
The Depository Trust Clearing Corporation is calling for a dedicated central clearer that would ensure stability in trading and transparency in the huge U.S. repo market. The DTCC intends to submit a rule filing with the Securities Exchange Commission (SEC) and an Advance Notice filing to both the SEC and the Federal Reserve to provide central clearing. DTCC said that central clearing would play a key role in providing stronger participant and systemic safeguards for the tri-party repo market. FICC, the DTCC’s fixed income subsidiary, provides the only central clearing function for tri-party repo trades in the U.S. and is the only platform ready to serve this market.
DTCC said that the intended rule filing will outline FICC’s proposal to leverage its existing risk management and trade guarantee services for the institutional tri-party repo market in the U.S. Implementing FICC’s central counterparty (CCP) services for these transactions would increase operational efficiencies, guarantee completion of eligible trades, and lower the risk of a liquidity drain in the event of a dealer failure by extending its netting services.
“Centralizing the clearing and settlement of repo transactions through FICC could potentially help to prevent another squeeze in tri-party funding such as the one observed in 2008 when Funds sharply reduced their lending during the run up to the Lehman failure,” said Murray Pozmanter, DTCC Managing Director and Head of Clearing Agency Services. “It would also provide regulators with a broader and more comprehensive view of the repo market for the monitoring and management of systemic risk as well as mitigate risks associated with a fire-sale in the tri-party marketplace.”
The intended rule filing remains subject to regulatory review and approval by the SEC and the Federal Reserve Board in all respects.
How the Proposed Service Would Work
Subject to regulatory review, the proposed service would allow the submission of institutional tri-party repo transactions between existing members of FICC’s Government Securities Division and investment companies registered under the Investment Company Act of 1940 (referred to as “RICs” or the “buyside”) where the RICs are the cash lenders in the transactions. A new limited GSD membership type would be created for tri-party money lenders. This membership type would be separate from full GSD service membership and would relieve RICs of being subject to full GSD membership requirements.
The proposed service would include general collateral financing (GCF Repo) eligible collateral, or approximately 74 percent of the over $1.6 trillion tri-party repo market.
FICC said that its proposed service would: Reduce counterparty risk by guaranteeing the completion of settlement in a member default scenario, existing members could be eligible for balance sheet offset. Centralized liquidation of a failed counterparty would reduce the potential for market disruption and fire-sale risk. Decreased settlement and operational risk via CCP netting, novation and risk management.
Protecting from Fire-Sale Risk
Fire sale risk remains a critical policy concern of the Federal Reserve and other members of the U.S. regulatory community. A solution to this problem is central liquidation (which FICC already offers in all of its clearing arrangements). RICs receive securities as collateral, so the concern is that if there is turbulence in the market resulting in dealer defaults, the RICs will need to sell large amounts of securities, which could dramatically reduce the value of the securities they are looking to sell.