The Federal Reserve Bank of New York said the two large Fed
clearing banks, Bank of New York Mellon Corp. and J.P. Morgan Chase
& Co., and other market participants would likely need more
time to complete remaining overhauls in a corner of financial
markets that contributed to the 2007-2009 crisis.
The New York Fed said in a statement that the two clearing banks
have made progress in reducing the amount of intraday credit they
are extending to dealer banks to below a self-imposed target, a
sign of approval from the central bank about work completed in the
reforms.
In its statement Wednesday, the New York Fed said the measure of
intraday credit outstanding at the clearing banks had fallen to an
average of 3%-5%, below the 10% target a Fed-sponsored task force
set years earlier and down from 100% as recently as 2012.
Still, the statement pointed to continued risks and the
potential for missed deadlines in reforming the market for
so-called repurchase agreements, or repos, including getting trades
settled when more than one big clearing bank is involved. The banks
were supposed to address risks in this segment of the market by
year-end, but the New York Fed said the deadline might be not be
met.
The Fed has been trying to reduce the exposure of the two big
banks to this market, in which they act as a bridge for financing
between securities dealers who need access to cash and the cash
providers at money-market funds, who want to invest in short-term
securities.
The intraday credit milestone is the latest evidence of the New
York Fed's drive to clean up the corner of funding markets for
repos, a multitrillion-dollar market in which financial
institutions swap bonds for cash. The so-called tri-party repo
market, in which institutions use one of the two clearing banks to
facilitate and settle their funding and collateral trades, has been
a key focus for the New York Fed since weaknesses surfaced in the
financial crisis.
Ever since then, the New York Fed has undertaken a series of
measures to clean up the market, out of fears that a destabilizing
event or default at one of the large dealers participating in
tri-party repo market would ricochet across financial markets,
potentially leading to forced selling of securities in a downward
spiral known on Wall Street as a fire sale.
The New York Fed's task force on tri-party repo infrastructure
reform in 2012 released a road map for extra developments that
needed to be undertaken to finish the job, and said on Wednesday
many of those goals have been met. The lowering of intraday credit
below the taskforce's own target is evidence that the industry has
made significant progress.
One continued problem, however, is aligning another part of the
tri-party repo for general collateral or "GCF" repo, with the rest
of the tri-party market's settlement timelines. As of now, trades
that settle for dealers clearing through the same clearing bank are
fully integrated with the new overhauls. But trades that have to
settle between dealers who use different clearing banks are out of
lockstep.
That remaining slice of GCF repo trades "still require uncapped,
discretionary extensions of intraday credit by the clearing banks,"
the New York Fed said in its statement, adding, "This is a
potential source of market instability in periods of stress."
The New York Fed originally set a timeline for completing that
remaining piece of the reforms for the end of 2015, but in its
statement it said market participants recently indicated they may
need more time because the work to automate the process is complex.
The work "may stretch beyond 2015," it said.
The work being undertaken by the industry "just brings that last
small piece of GCF in line with the rest of the new tri-party
settlement process," said Murray Pozmanter, managing director and
head of clearing agency services at Depository Trust & Clearing
Corp., a utility controlled by large banks that is involved in the
reforms.
The other risk that hasn't been fully addressed is the risk of
fire sales in collateral, which some traders envisaged could be
solved with a clearinghouse that would expand the number of
participants in the market and create a pool of money in reserve to
cover the default of a repo member. The Fed has been agnostic so
far about all solutions the industry has proposed, including which
clearinghouse operator to use, although proposals have been put
forward by DTCC and talked about by LCH.Clearnet Group Ltd. and CME
Group Inc., among others.
DTCC is waiting for approval on its proposal from the Securities
and Exchange Commission, but the New York Fed as the company's
prudential regulator also has to be on board with its solution. The
company hopes to launch the clearinghouse later this year, Mr.
Pozmanter said.
The New York Fed says as yet no perfect solution to fire sales
exists. In the statement, it said it, "acknowledges current
industry efforts to develop central clearing mechanisms for repo
financing, which may offer opportunities to establish a process for
orderly liquidation of assets of a defaulted member," but more work
was needed.
Write to Katy Burne at katy.burne@wsj.com
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