Money markets tri party repo risk stirs debate

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* Role of high-risk collateral discussed * More transparency viewed as desirable By Ellen Freilich NEW YORK, March 7Risk in a market that is a key funding source for large securities dealers has recently prompted some debate after a study said the amount of higher-risk paper pledged in repo transactions had risen to pre-financial crisis heights. A repo, or repurchase agreement, is a sale of a security coupled with an agreement to repurchase the security at a specified price at a later date. In the tri-party repo market, the three participants are the cash lenders, the cash borrowers, and the tri-party agent who facilitates the transactions. In the United States, cash lenders are made up mainly of mutual funds, custodial banks and other asset managers. Cash borrowers are typically fixed income securities broker dealers with securities that can be used as collateral. The tri-party agent is one of two government securities clearing banks. The large securities dealers depend on the tri-party repo market for the bulk of their short-term funding, while cash investors, such as money market mutual funds, count on it to be a very safe short-term investment. After the financial crisis exposed the vulnerabilities of the tri-party repo market's infrastructure, a task force was formed under the auspices of the Payments Risk Committee, a private sector body sponsored by the Federal Reserve Bank of New York. The group's final report, released last month, described numerous recommendations and the degree of their implementation - all intended to address potential systemic risk concerns. MORE RISK OR LESS? Against that backdrop, a study by Fitch Ratings rang an alarm, asserting the amount of higher risk "structured finance" paper pledged in repo transactions had risen as a portion of the overall collateral mix and returned to pre-crisis levels. Last week the Liberty Street Economics blog - published on the New York Fed's website but not necessarily reflecting the position of either the New York Fed or the Federal Reserve System - said the content of the Fitch seemed "worrisome" at first glance. But public data from the Tri-Party Repo Infrastructure Reform Task Force reveal "no evidence of a broad-based increase in riskier types of collateral," wrote Antoine Martin, an economist at the New York Fed, on the Liberty Street blog. The data represent 100 percent of the market's volume, while the Fitch study was based on data from a sample of prime funds, representing just 5 percent of the market's size. Prime funds invest in a diversified portfolio of high quality, short-term, U.S. dollar-denominated money market instruments. The Fitch study found a gradual increase in the share of riskier collateral financed through repos, in particular a big increase in the share of "structured finance" collateral - a type of collateral that had almost completely disappeared from the market during the financial crisis. Since the monthly data provided by the task force has only been published since May 2010, it does not allow comparisons with market dynamics in place before or during the financial crisis, but it makes it possible to look at recent trends, Martin wrote in his blog. Separating safer collateral (securities issued by the U.S. government or by government-sponsored enterprises) from riskier collateral (securities not issued by these institutions) shows the share of riskier assets serving as collateral in the tri-party repo market has decreased since mid-2011, Martin said. The amount of riskier assets like equities, corporate bonds and structured finance being financed in the tri-party repo market has also been decreasing slightly, he said. Meanwhile, median "haircuts" - the difference between the value of the collateral and the amount of cash received against it in a repo transaction - have been roughly flat, Martin said, with the exception of haircuts for structured products, which have recently increased. Responding to the Liberty Street blog, Fitch said it had based its conclusions on Securities and Exchange Commission data on money funds but remarked on the "excellent high-level overview" provided by the New York Fed data, which benefited from timeliness and frequency. "Either way, the greater transparency afforded by both the FRBNY and SEC disclosures enhances the market's understanding of risk trends in this critical funding market," Fitch said. MIX OF FUNDERS COULD BE CHANGING Joseph Abate, market analyst at Barclays Capital in New York, said the mixture of tri-party repo collateral does not appear to have changed significantly since 2010, but there could be a change in the mix of funders. "In a search for higher yield, prime funds may be reallocating their repo transactions away from government paper toward structured finance collateral," he said. Prime funds boosted their share of repo allocations to 16 percent by December from 12 percent last spring, he noted. But if prime funds are increasing their structured finance repo and the total volume of paper being financed is unchanged, then another repo market cash provider must be lowering its exposure to this collateral type, Abate said. Who that cash provider might be is hard to figure out because money market funds are not the only cash lenders in the repo markets, he said. Securities lenders, insurance companies, and others are important sources of collateral financing but unlike the money funds, data on their holdings "are not reported on a granular or frequent basis. "Indeed, as noted by others, this is a reason for expanding data collection in this market," Abate said.

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