Task Force Failure Leads N.Y. Fed Take Lead on Repo Reform

NEW YORK — An industry group's failure to expeditiously reform the workings of one of the banking system's most important short-term financing markets is forcing the Federal Reserve Bank of New York to adopt a stronger monitoring role in the sector.

Responding to the latest report from a task force of financial institutions set up to build safeguards against systemic risk in the triparty repo market, the New York Fed expressed its disappointment with the speed at which the group is reducing the amount of overnight credit required to settle trades.

The repo market, which came under extreme stress following the failure of Lehman Brothers in September 2008, allows banks and other institutions to borrow and lend bonds and, in turn, provides a vital source of short-term financing to banks. Since that crisis, regulators have worried that settlement failure between two counterparties in that market could undermine the entire financial system. In response to that risk, the Fed commissioned the 23-member Tri-Party Repo Infrastructure Reform Task Force to come up with changes to reduce systemic risks.

A report released Wednesday by that group, which is chaired by UBS and includes a number of primary dealer banks, institutional investors and hedge funds, included some "accomplishments," the New York Fed said in a statement. But it added that "the amount of intraday credit provided by clearing banks has not yet been meaningfully reduced, and therefore, the systemic risk associated with this market remains unchanged."

As a result, the New York Fed said it "will intensify its direct oversight" of the triparty repo market. "While the Task Force has been an essential forum for generating and developing ideas, it has not proved to be an effective mechanism for managing individual firms' implementation of process changes," it added.

The New York Fed said it may restrict the types of collateral used in repo trading. It may also support the creation of an "industry-financed facility" that would help create an orderly liquidation of securities in the event of a dealer default.

"The [Fed's] message, is that they need to be proactive rather than being pushed to be reactive," said Kenneth Silliman, New York-based head of short-term rates trading at TD Securities.

One concern appears to have been the task force's projected timeframe for reforms, which focus on reducing settlement risk inside the two big clearing banks at the center of the repo market--Bank of New York Mellon Corp. and JPMorgan Chase & Co., both of which are members of the task force.

Changing that system "will require more time and technical implementation than the Task Force originally estimated and will constitute a multiyear project," the group's report said. It noted that the reform agenda, which will also engage the Fixed Income Clearing Corporation and other market participants, "requires firm-specific actions, rather than the idea generation and vetting that the Task Force provided."

The group said that its primary goal is "the practical elimination of intraday credit associated with the settlement of triparty repo transactions."

In September, New York Fed President William Dudley said he had "doubts" about the market's attempt to heal itself. Citing the difficulty of reconciling financial stability with firms' individual business interests, Dudley said then "if the private sector falls short in this instance, public authorities may need to intervene and impose more forceful regulatory solutions."

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