FED plans revamp of repo markets after Lehman debacle

Discussion in 'Wall St. News' started by ASusilovic, Jun 22, 2009.

  1. The US Federal Reserve is considering dramatic changes to the giant repurchase – or repo – markets where banks around the world raise overnight dollar loans.

    The plans include creating a utility to replace the Wall Street banks that handle transactions, people familiar with the matter say.

    The Fed’s deliberations are partly motivated by concerns that the structure of the US overnight repurchase market may have exacerbated the financial turmoil that accompanied the failure of Lehman Brothers in September last year.

    Fed officials plan to meet next month with market participants to discuss reforms.

    People familiar with the Fed’s thinking say it is looking into the creation of a mechanism to replace the clearing banks – the biggest of which are JPMorgan Chase and Bank of New York Mellon – that serve as intermediaries between borrowers and lenders.


    Push to reduce risks in short-term funding

    The demise of leading US investment banks last year focused regulatory attention on a crucial area of financial plumbing and sparked a debate about the future of the repurchase – or repo – market.

    With big investment banks funding up to half of their balance sheets through repo last year, policy_makers and the industry are trying to cut the risk of relying on this type of short-term funding, which can evaporate quickly in a crisis and potentially roil a clearing bank.

    Kelly Mathieson, managing director of clearance and collateral management at JPMorgan, says: “We are of the view that the US tri-party repo market will require behaviour and process changes – from dealers, lenders and clearing agents.”

    Traders suggest the repo market could adopt a derivatives clearing house approach, where there are layers of capital set in place to absorb any future failure of a dealer. In such a scenario, the central bank would be the lender of last resort. Aspects of the European repo model, which include a central counterparty, could be adopted. The flexibility of the European tri-party repo market (see box), which allows users to switch between different types of collateral, helped ease funding strains last year.

    The European Central Bank also accepts a wide range of collateral from a variety of users.

    While even in the European repo market lenders became unwilling to accept lower quality collateral, it is widely believed that the region’s market performed better than the US’s during the crisis.

    “The market functioned quite well, although some activity was hampered,” said Godfried De Vidts, chairman of the European Repo Council.

    Making the process by which dealers estimate margin requirements for their repo transactions more transparent will, it is believed, also help lenders and regulators compile an accurate picture of how exposed any one dealer is to the repo market and what types of assets they are funding.