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A two-year inquiry into tri-party repurchase agreements has not figured out how to fully eliminate systemic risk from this arcane market.
February 15
WASHINGTON — A Federal Reserve Board official testified Thursday that the Financial Stability Oversight Council might have to assume responsibility for overhauling a large but obscure financial market that is a potential source of systemic risk.
The tri-party repo market was first flagged as vulnerable during the 2008 financial crisis, when it proved susceptible to runs, and helped spur the creation of one of the Fed's emergency liquidity programs. The following year, an industry task force was established to increase the market's stability, but succeeded in accomplishing only a few of its goals.
Sen. Jack Reed cited a key problem during a congressional hearing on Thursday, noting that no single regulator is in charge of the market, given that the Fed, New York Fed and Securities and Exchange Commission all play some role.
"Who's the person who's got the mission to do this?" Reed asked. "When everyone's in charge, no one's in charge."
Matthew Eichner, deputy director of the Fed's division of research and statistics, agreed that the regulatory landscape is fragmented, and hinted FSOC may need to step in.
"The 2010 Dodd-Frank Act did also create a Financial Stability Oversight Council, which does have, I think, a clear statutory responsibility to deal with situations where things threaten," Eichner told the Senate securities subcommittee.
Reed, who chairs the subcommittee, called the hearing on the heels of the
The report called on the industry to implement key reforms within the next 6-12 months, rather than over multiple years, as industry officials have said will be necessary. But the report did not lay out a specific role for FSOC if reforms do not come more quickly.
The tri-party repo market serves as a source of short-term borrowing for banks, money market funds, insurance companies and securities dealers. Standing between the two counterparties in the transaction is a clearing bank, which is generally either Bank of New York Mellon Corp. or JPMorgan Chase & Co.
The market is currently worth about $1.8 trillion, down from a peak of $2.7 trillion five years ago.
One major concern about the market's current structure is that within each trading day, the clearing banks extend a substantial amount of credit to counterparties in the trades. As a result of work done by the industry task force, those exposures are now closed out in a narrower window of time.
Still, there remain significant intraday exposures. The fear is that during a period of market stress, a clearing bank could stop providing intraday credit, which could in turn cause a sudden loss of funding for the large dealer banks that participate in the market.
Karen Peetz, vice chairman and chief executive officer for financial markets and treasury services at BNY Mellon, testified Thursday that her institution is developing technology that will practically eliminate worrisome intraday exposures by the end of 2014.
But Reed questioned whether that is soon enough, especially in light of the financial instability in Europe.
"We don't want to be told, 'Yes, we'll get this done in 2014. Trust us,'" Eichner responded. "What we want to see is a very clear path to getting all of this done by 2014, but with many intermediate steps and pieces of risk reduction that occur along the way."
A second concern about the market involves the possibility that one of the large dealer banks will default. In such a scenario, a dealer might hold collateral worth more than $100 billion, which would become difficult to liquidate without sparking a fire sale.
"A solution to this fire-sale problem likely requires a marketwide collateral liquidation mechanism," Eichner stated. "But challenges in designing and creating a robust mechanism are appreciable."
Also testifying at Thursday's hearing were representatives of Morgan Stanley and State Street Global Advisors, both of which are large participants in the tri-party repo market.
Witnesses from both firms acknowledged that the reforms implemented so far do not go far enough. But they also suggested that industry participants are in position to take the necessary additional steps.
"What is required is collaboration between the bank dealers and the two clearing banks to provide a set of strategic steps to begin a tactical but meaningful reduction of intraday credit extension," said Thomas Wipf, managing director at Morgan Stanley.
"We believe that the status quo is unacceptable, and by beginning this reduction through prudent liability management, we can reduce risk."
But Reed and Sen. Mike Crapo, the subcommittee's top Republican, both seemed convinced that one federal agency needs to take responsibility for making sure the reforms happen in a timely fashion.
"I do think we need to get a much more definitive, clarifying sort of notion of who is in charge here," Reed said.
