The tri-party repo market, in which sellers trade securities (collateral) to buyers in
exchange for cash with an agreement to return the cash and get back their securities at an agreed date, is a large and important source of short-term funding for securities dealers
who need short-term cash to fund their positions; consequently, this market is a potential source of systemic risk through the resultant liability connectedness.16 As of October 2013, the total value of the tri-party repo market was approximately $1.6 trillion with
approximately 81 percent involving treasuries or agency securities.17 The total value of tri- party repo market peaked in 2008 at approximately $2.8 trillion.18 Repos constitute a significant portion of the funding for large US financial institutions. As a percentage of total assets at the end of 2014, repos accounted for 10.3 percent of Goldman Sachs’
funding, 6.5 percent of JPMorgan’s, 8.0 percent of Citigroup’s, 9.6 percent of Bank of America’s, and 8.7 percent of Morgan Stanley’s.19
In the repo market, the repo seller—the party receiving cash—pays the repo buyer—the supplier of the cash—a return that reflects the low level of risk due to the posting of the securities as collateral.20 In the tri-party repo market, a clearing bank both supplies cash to the seller and holds the securities on behalf of the buyer. Because it may not receive both cash and securities simultaneously, from the two parties to the transaction, the clearing bank is thus exposed to potential losses in the event that either side of the repo were to default.21 This phenomenon is referred to as “intraday credit risk.” In the United States, two banks, JPMorgan Chase and BNY Mellon, serve as the clearing banks in the tri-party repo market.
In the wake of the financial crisis, the FRBNY has sponsored an industry-led effort to study the problem of the concentration of a dangerous amount of counterparty risk on the two clearing banks.22 Significantly, in 2009, the FRBNY established the Tri-Party Repo Infrastructure Reform Task Force.23 Since then, the task force has convened workshops and issued a series of reports recommending ways to reduce intraday credit dependence, and thus the exposure of the clearing banks.24 The FRBNY also released its own white paper in May 2010, discussing possible reforms.25 Since the establishment of the task force, several concrete steps have been taken to reduce intraday credit exposures.
First, the two clearing banks have implemented various collateral optimization
capabilities that reduce intraday credit exposures.26 The task force has already met its goal of reducing the share of tri-party repo volume that is financed with intraday credit from a clearing bank: today, 3 to 5 percent of tri-party repos are financed with intraday credit, compared to 100 percent in 2012. 27 Second, the daily “unwind” of most tri-party repo transactions has been moved from early morning to midafternoon, reducing the duration of intraday credit extensions.28 Third, many dealers have undertaken efforts to reduce their reliance on intraday funding in accordance with Basel III liquidity
regulations.29 Finally, both clearing banks are implementing key changes in their
respective settlement processes. These changes are expected to reduce intraday credit risk further while improving the resiliency of the settlement process.30
~ ~ ~
While the deeper integration of modern financial markets has been said to lead to a
“robust-yet-fragile” system, neither the Lehman’s failure nor the runs on MMF presented important liability connectedness risks, primarily because neither Lehman nor money
market funds were significant funders of major banks. However, the tri-party repo market remains a liability connectedness risk.
Notes
1. See, for example, Franklin Allen and Douglas Gale, Financial contagion, 108(1) Journal of Political Economy 1, 4 (2000); Xavier Freixas, Bruno Parigi, and Jean-Charles
Rochet, Systemic risk, interbank relations, and liquidity provision by the central bank, 32(3) J. Money, Credit, Bank. 611 (Aug. 2000).
2. See, for example, Douglas Diamond and Raghuram Rajan, Liquidity shortages and banking crises, 60(2) J. Fin. 615 (Apr. 2005).
3. Lehman Brothers Holdings Inc., Form 10-Q, at 23 (May 31, 2008).
4. Using the $1,739bn total 2008 market figure from Richard Anderson and Charles Gascon, The commercial paper market, the Fed, and the 2007–2009 financial crisis, Federal Reserve Bank of St. Louis Review 589, 594 (Nov./Dec. 2009), available at https://research.stlouisfed.org/publications/review/09/11/Anderson.pdf.
5. Id.
6. Id.
7. The $10m estimate is from Gary Gorton and Andrew Metrick (Yale ICF Working Paper No. 09–14, 12, Nov. 2010). However, the total size of the repo market can only be
estimated and is not known with specificity. See Adam Copeland, Isaac Davis, Eric LeSueur, and Antoine Martin, Mapping and sizing the U.S. repo market (Jun. 25, 2012), available at http://libertystreeteconomics.newyorkfed.org/2012/06/mapping- and-sizing-the-us-repo-market.html.
8. David Scharfstein, Perspectives on Money Market Mutual Fund Reforms,Testimony before the S. Comm. on Banking, Hous. & Urban Affairs (Jun. 21, 2012), available at http://www.banking.senate.gov/public/index.cfm?
FuseAction=Files.View&FileStore_id=ca1f8420-b2de-46dd-aee1-9a22d47b198c.
9. Id. at 2.
10. Id. at 2.
11. Marco Cipriani, Antoine Martin, and Bruno M. Parigi, Money market funds
intermediation, bank instability, and contagion, Fed. Res. Bank of New York, Staff Report No. 599 (Feb. 2013).
12. Sean Collins and Chris Plantier, Do U.S. Banks Rely Heavily on Money Market Funds?
No., Inv. Co. Inst. (Nov. 14, 2012).
13. Prime MMF funding, Top 50 holding companies, Fed. Fin. Inst. Examination Council, Crane Data (Jun. 30, 2013), available at http://www.cranedata.com.
14. Naohiko Baba, Robert N. McCauley, and Srichander Ramaswamy, U.S. dollar money market funds and non-U.S. banks, BIS Q. Rev. 65 (Mar. 2009).
15. Sean Collins and Chris Plantier, Money market funds continued to reduce eurozone holdings in November (Dec. 16, 2011), available at
http://www.ici.org/viewpoints/view_11_mmfs_holdings_update.
16. Adam Copeland, Antoine Martin, and Michael Walker, Repo runs: Evidence from the tri-party repo market, Federal Reserve Bank of New York, Staff Report No. 506, at 9 (Jul. 2011; revised Aug. 2014), available at
http://www.newyorkfed.org/research/staff_reports/sr506.html (noting that “[b]efore Lehman declared bankruptcy, almost $2.5 trillion worth of collateral was posted in the tri-party repo market each day”). See also Eric Rosengren, Short-term wholesale
funding risks, Federal Reserve Bank of Boston (Nov. 2014), available at
http://www.bostonfed.org/news/speeches/rosengren/2014/110514/110514text.pdf.
17. Tri-Party Repo Statistical Data, Federal Reserve Bank of New York (Oct. 2013), available at http://www.newyorkfed.org/banking/tpr_infr_reform_data.html.
18. Copeland et al., supra note 16, at 9.
19. Goldman Sachs, Form 10-K, at 167, 209 (2014). JPMorgan Chase & Co., Form 10-K, at 32, 128 (2014). Citigroup, Form 10-K, at 27, 204 (2014). Bank of America, Form 10-K 27, 224 (2014). Morgan Stanley, Form 10-K, at 58, 310 (2014).
20. Task Force on Tri-Party Repo Infrastructure, Federal Reserve Bank of New York, at 3 (May 17, 2010), available at http://www.newyorkfed.org/prc/files/report_100517.pdf.
21. Id.
22. See, for example, William C. Dudley, Fixing wholesale funding to build a more stable financial system, Remarks at New York Bankers Association’s 2013 Annual Meeting &
Economic Forum (Feb. 1, 2013), available at
http://www.newyorkfed.org/newsevents/speeches/2013/dud130201.html; see also Bruce Tuckman, Systemic risk and the tri-party repo clearing banks, Center for Financial Stability Policy Paper (2010).
23. Press Release, Tri-Party Repo Infrastructure Reform, Federal Reserve Bank of New York (2015), available at http://www.newyorkfed.org/banking/tpr_infr_reform.html.
24. See, for example, Progress report, Task Force on Tri-Party Repo Infrastructure, Federal Reserve Bank of New York (Jul. 6, 2011), available at
http://www.newyorkfed.org/tripartyrepo/pdf/tpr_progress_report_110706.pdf; Press
release, Tri-Party Repo Infrastructure Reform Task Force issues progress report on direction of reform, Federal Reserve Bank of New York (Jul. 6, 2011), available at
http://www.newyorkfed.org/tripartyrepo/pdf/PR_110706.pdf; Final report, Task Force on Tri-Party Repo Infrastructure, Federal Reserve Bank of New York (Feb. 15, 2012), available at http://www.newyorkfed.org/tripartyrepo/pdf/report_120215.pdf; website, Tri-Party Repo Infrastructure Reform Task Force, NewYorkFed.org (2015), available at http://www.newyorkfed.org/tripartyrepo/.
25. See White Paper, Tri-Party Repo Infrastructure Reform, Federal Reserve Bank of New York (May 17, 2010), available at
http://www.newyorkfed.org/banking/nyfrb_triparty_whitepaper.pdf.
26. See Press Release, Recent developments in tri-party repo reform, NewYorkFed.org (Dec. 20, 2012), available at
http://www.newyorkfed.org/newsevents/statements/2012/1220_2012.html (noting that JPMC has stopped the daily unwind of non-maturing repo trades, and BNYM has implemented changes to eliminate intraday credit that BNYM provides to dealers against privately issued securities that settle through the Depository Trust Company).
See also Press Release, J.P. Morgan achieves major milestone in tri-party repo market reforms (Nov. 19, 2012).
27. Update on Tri-Party Repo Infrastructure Reform, Federal Reserve Bank of New York (Jun. 24, 2015), available at
http://www.newyorkfed.org/newsevents/statements/2015/0624_2015.html
28. Final Report, Task Force on Tri-Party Repo Infrastructure, Federal Reserve Bank of New York, at 3 (Feb. 15, 2012), available at
http://www.newyorkfed.org/tripartyrepo/pdf/report_120215.pdf.
29. Id. at 4.
30. See Statement, Recent developments in tri-party repo reform, Federal Reserve Bank of New York (Dec. 20, 2012), available at
http://www.newyorkfed.org/newsevents/statements/2012/1220_2012.html. For example, the Federal Reserve reiterated to the clearing banks that final settlement of tri-party repo transactions should be completed sufficiently in advance of the
Fedwire® Funds close in order to provide enough time for successive funds transfers.
Id.
6 Dodd–Frank Act Policies to Address Connectedness
The Dodd–Frank Act was the principal response of the United States to the 2008 financial crisis. 1 Despite the fact that the crisis actually had little to do with asset connectedness, many of the most important provisions of the Act are addressed to this form of systemic risk. This is not to say these policies are bad and may not address potential problems in the future, but as we will see, contagion was the major problem in the crisis, and Dodd–
Frank made this problem worse, not better.
There are three key provisions of Dodd–Frank addressed to asset connectedness: (1) the requirement for central clearing of over-the-counter derivatives,2 (2) the imposition of counterparty exposure limits,3 and (3) the designation of systemically important nonbank financial institutions.4