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US regulators warn of tri-party repo flaws
19 July 2012
The Financial Stability Oversight Council’s annual report says there has been “limited progress” in tackling risk in the US tri-party repo market
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US regulators have criticised the US tri-party repo industry’s promises to reform the system in a new annual report from the Financial Stability Oversight Council.
The Council, which is made up of several regulators and is chaired by the Treasury secretary Tim Geithner, said the proposed multi-year timeline to reform the tri-party repo market is “unacceptable” and warned of “structural vulnerabilities” in the system. The Federal Reserve Bank of New York had commissioned an industry taskforce to tackle issues in the market but earlier this year the taskforce requested at least five more years to improve the market.
In the report, the panel of regulators called for more government involvement. The regulators’ concern is that the market depends on just two clearing banks, JPMorgan and BNY Mellon, to provide the $1.7trn funding need.
The report said: “This is a potentially unstable situation. In times of market stress, the clearing bank faces a conflict of interest between its own risk management needs and the role it performs as a lender to dealers experiencing funding problems.”
The Council also said there has been “limited progress” on reducing the market’s reliance on intraday credit and that there is an absence of a mechanism to ensure an orderly liquidation of tri-part repo collateral by creditors of a defaulting dealer. If a large dealer defaults, lenders could be left with billions of dollars of collateral that they would likely seek to liquidate rapidly, potentially depressing prices and even damaging market liquidity.
To deal with these problems, the regulatory panel suggested the implementation of near-term steps to reduce intraday credit usage in the next six to 12 months as well as improvements in risk management practices across all market participants. It also recommended that regulators and industry participants join forces to define collateral management standards in tri-party repo markets.
Rumours are also circulating that the task to improve the market should instead be handed over to an infrastructure provider which would likely be the DTCC.