New Worry in 'Repo': Just One Bank for $3.5 Trillion Market
August 30 2017 - 12:40PM
Dow Jones News
By Katy Burne
When ED&F Man Capital Markets in June opened a settlement
account for government bonds at Bank of New York Mellon Corp., it
was a watershed moment in the world of "repos."
London-based ED&F became the first bond broker to change
clearing banks in this obscure but vital corner of the global
financial system in nearly a decade.
The move signaled that a market whose resistance to change has
long vexed regulators is now shifting in a way that intensifies
many traders' concerns about repo safety.
Bank of New York's onetime sole rival in the business of
clearing U.S. Treasurys and repos backed by them, J.P. Morgan Chase
& Co., is exiting the business, prompting more than two dozen
brokers to move to Bank of New York.
Individual brokers' transitions have by all accounts been
smooth. Yet many traders fret over the risks of having a single
bank handle all clearing and settlement -- the process of
completing trades and distributing funds according to contract --
in a short-term lending market estimated by the Treasury's Office
of Financial Research at $3.5 trillion.
Many worry that having all those transactions handled by just
one clearing bank potentially exposes the world's safest bond
market to threats ranging from mundane power outages to
cyberattacks and terrorism.
"This clearing function is only in one bank now and is so
systemically important," said Scott Skyrm, head of repo at Wedbush
Securities, a Los Angeles broker dealer.
In repos, or "repurchase agreements," lenders such as
money-market funds make short-term loans to bond brokers, often
using government bonds as collateral.
The market has been targeted by the Federal Reserve for reform
for nearly a decade. Those efforts picked up after shortcomings in
repos were exposed in 2008, when lenders' retreat from Bear Stearns
Cos. and Lehman Brothers Holdings Inc. played a role in
accelerating the financial crisis.
Troubles at those firms and others, driven in part by their
exposure to subprime-lending losses and reliance on short-term
loans to fund longer-term investments, helped pave the way for an
updated repo market.
A decade ago, many financial firms funded themselves "wholesale"
by borrowing in the market overnight. Today, repo borrowings tend
to be longer-term and backed by stronger collateral, such as
Treasury securities rather than privately issued mortgage
bonds.
"When bad things happened in 2008, we saw that there were
virtually no bids in the market for anything other than the
risk-off sovereign market, " said Mark Robinson, a former managing
director at Bank of New York and most recently a business
development executive at fintech company Broadridge Financial
Solutions.
Regulators have been trying on and off for years to resolve
concerns about problems in repo spilling over to broader financial
markets.
In April, Federal Reserve Bank of New York President William
Dudley wrote that repo markets pose risks to market functioning and
"are not settled yet," in part because participants can still
choose to raise cash in a hurry by selling assets in a so-called
"fire sale."
With J.P. Morgan's 2016 decision to retreat from clearing
government securities, concerns about market stability began
falling squarely on Bank of New York, which already controlled 85%
of the market. The company this past May formed a new unit with a
separate governance team to oversee the repo business,
acknowledging its unique role and responsibility.
Bank of New York this summer began transitioning some clients of
J.P. Morgan. Besides ED&F, it has also added as new clearing
clients INTL FCStone and Landesbank Baden-Württemberg. In all,
about 30 are expected to move.
"We were nervous at first," said Bruce Fields, group treasurer
at INTL FCStone. But he said his fears have been allayed since his
firm's conversion on July 10, which he said has provided access to
a wider array of repo lenders than at J.P. Morgan.
Beyond Bank of New York, efforts to make repo safer continue. In
May a unit of Depository Trust & Clearing Corp., a financial
plumbing firm controlled by large banks, got permission from the
Securities and Exchange Commission to expand a repo safety net
already in use for bond brokers, covering institutional investors
too. Some view this as potentially mitigating fire sales. Hedge
fund firm Citadel LLC joined in June.
Trading volumes have shrunk, owing to new rules that have levied
extra capital charges on banks. Other rules have meant more repos
are locked in for longer terms, reducing the incentives for firms
to borrow short term while lending long term and creating an
unsound condition known as an asset-liability mismatch.
Perhaps most important, the hundreds of billions of dollars in
intraday loans that J.P. Morgan and Bank of New York once made
every morning to bond brokers have been reduced by 97%, according
to Fed estimates, virtually eliminating the exposure the two
clearing banks had precrisis to a broker default.
Write to Katy Burne at katy.burne@wsj.com
(END) Dow Jones Newswires
August 30, 2017 12:25 ET (16:25 GMT)
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