The Federal Reserve Bank of New York (“FRBNY”) released a white paper (the “White Paper”) addressing policy concerns with weaknesses in the infrastructure of the tri-party repurchase agreement (“repo”) market. The White Paper includes the recommendations of the Tri-Party Repo Infrastructure Reform Task Force (the “Task Force”) created by the Payments Risk Committee, which is a private-sector group of senior U.S. bank officials that is sponsored by the FRBNY. The White Paper notes three significant policy concerns associated with the design of the tri-party repo market infrastructure: (1) 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, (2) the risk management practices of cash lenders and clearing banks, and (3) 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 broader financial system.
In addressing these concerns, the Task Force identified the following areas for improvement: operational arrangements, dealer liquidity risk management, margining practices, contingency planning, and transparency. The Task Force’s recommendations include, among other things, “auto-substitution,” which will allow for the automated substitution of securities collateral supporting a tri-party repo transaction, while that transaction remains in place; adjustment by dealers of their liquidity risk management plans and liquidity buffers; statistical analysis by market participants and stress testing of collateral price movements; the development of “liquidation plans” for the management and liquidation of repo collateral in the event of a dealer default; and the use of a template developed by the Task Force for regular publication of key information provided by the clearing banks.
Other Areas of Concern
The FRBNY notes in the White Paper that the Task Force’s recommendations do not address all areas of concern. For example, the steps proposed to increase cash investors’ preparedness for the sudden failure of a large dealer do not directly address concerns that such failure could prompt the simultaneous liquidation of large amounts of assets and create fire-sale conditions. In addition, the FRBNY states that the recommendations will not materially alter the propensity of cash investors to run from a troubled dealer.
Comments are requested by the FRBNY on the anticipated impact of the recommendations, implementation challenges, and additional steps that could be taken to strengthen the resiliency of the infrastructure supporting the tri-party repo market. The White Paper includes a list of questions to encourage meaningful discussion and thoughtful analysis of the issues. The FRBNY requested that comments be submitted by June 16, 2010.