Is $50 Billion the Price of Repo Safety?
A firm at the center of the U.S. financial plumbing is seeking $50 billion in commitments from banks and trading firms to shore up a crucial but increasingly illiquid short-term lending market, according to people familiar with the market discussions.
Depository Trust & Clearing Corp. wants its members to support the multibillion-dollar credit line to bolster the finances of a unit called Fixed Income Clearing Corp. , which facilitates trades in the $2.6 trillion repo market, the people said.
Repos, or repurchase agreements, are short-term loans secured by U.S. Treasurys and other bonds. They play a critical role in the financial system by keeping cash and securities circulating among hedge funds, investment banks and other financial firms.
Regulators at the Federal Reserve and the Securities and Exchange Commission are pushing DTCC, which operates the U.S. repo market's only clearinghouse, to bolster the unit's credit backstop, said people familiar with the matter. Some said the regulators believe the DTCC unit's resources aren't enough to cover a large default that would threaten to cause repo lending to seize up.
Regulators have pushed to expand the use of clearinghouses since the 2008 financial crisis in a bid to prevent a recurrence of the panic that followed the failure of Lehman Brothers Holdings Inc. Clearinghouses pool capital from their members and assume the risk of a default, potentially limiting damaging "fire sales" of collateral in the event a major participant becomes insolvent.
"DTCC is currently working with its regulators and our clients" on a proposal that aims to ensure its unit "has sufficient backstop liquidity resources," Timothy Cuddihy , managing director in enterprise risk management at DTCC, said in an e-mailed statement. He said the plan seeks to be "aligned with U.S. and international regulatory standards and will protect the clearinghouse and its membership from future defaults."
The DTCC unit's proposal is the latest twist in a yearslong struggle to reduce risks in the repo market. Analysts warn that vulnerable repo markets could make it harder to buy and sell securities underlying the trades, a key concern at a time when the Fed is preparing to raise short-term interest rates for the first time since 2006.
Liquidity in the market is declining in part because trading requires banks to tie up a lot of capital, hurting their overall returns. Morgan Stanley's repo books contracted 47% last year, The Wall Street Journal reported in April. Goldman Sachs Group Inc.'s shrank by 46% last year to their lowest levels since November 2008 , regulatory filings show.
Traders said such declines are contributing to unusual swings in government-bond prices and raising concerns about the sorts of disruptions that haven't been felt since 2008. Some of them warn changes in the repo markets are already making it harder to buy and sell U.S. Treasurys at a time when U.S. regulatory agencies are paying increasing attention to such gyrations.
While the credit facility at the clearinghouse would add new costs, it would take risks away from the banks and let them reduce their capital charges, traders said.
"Expanded repo clearing could potentially bring a range of benefits," said Fed governor Jerome Powell at a conference last month in New York .
The amount and terms of the DTCC's proposal are confidential and could yet change, said people familiar with it. The plan already has fueled a clash between the largest banks that historically dominated repo trading and the smaller securities dealers that also are members of the DTCC unit.
Smaller members have balked at sharing the costs of the new credit facility, and some have warned they may have to drop out of the clearinghouse. Traders said such an exodus could concentrate risk among the remaining members and threaten the clearinghouse's ability to make good on a defaulter's financial obligations.
"To force a facility of that size on all dealers, banks and otherwise, could force some dealers to leave DTCC, reducing liquidity in the bond market," said James Tabacchi , president at South Street Securities LLC , an independent broker dealer and member of the DTCC unit.
DTCC has been planning to expand its U.S. repo clearing services, and the talks foreshadow its plans to seek SEC approval for the credit facility early next year, said people familiar with the company's plans.
Member firms are haggling over how much of the facility they will cover, said people familiar with the talks. The DTCC repo clearinghouse has more than 100 members, and the proposed allocation of the costs has changed at least three times, some of the people said. The latest plan would have banks and broker-dealers affiliated with banks shoulder more of the burden.
DTCC isn't asking for the cash upfront. Rather, firms would incorporate the funds into their planning for stressed market scenarios.
Officials at the clearer have told members they may not need such a large amount if dealers change some practices, for example by lending for shorter periods.
"The proposed facility will certainly create additional costs, but we feel these are far outweighed by the broad benefits of maintaining a stable and robust repo clearinghouse and, by extension, a healthier repo market," said Joe Noto , a managing director in the treasury department at $25 billion hedge fund firm Citadel LLC , whose securities arm is a DTCC member.
(END) Dow Jones Newswires
12-09-15 1916ET
Copyright (c) 2015 Dow Jones & Company, Inc.
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