UPDATE 1-U.S. repo reform task force issues first proposals

Tue Dec 22, 2009 5:34pm EST

(Adds comments from strategist, banks)

By Elinor Comlay

NEW YORK Dec 22 (Reuters) - A private sector task force said on Tuesday it agreed to take steps to reduce risks in the world's largest bank funding market, but has yet to tackle larger issues related to the collapse of Lehman Brothers.

The task force, charged by the New York Federal Reserve in September with making recommendations on fixing a funding market that amplified the financial crisis last year, released a progress report and said it plans to finish its work in the first quarter.

The $4 trillion market for repurchase agreements, contracts for the sale and future repurchase of a financial asset -- known as the tri-party repo market -- is a key part of the financial system's plumbing.

The tri-party repo market, where clearing banks JPMorgan Chase & Co (JPM.N) and Bank of New York Mellon Corp (BK.N) facilitate trades between counterparties and hold collateral, makes up a large portion of the repo market. The system was at the center of Lehman Brothers' collapse last year after some lenders lost confidence in its collateral on an overnight basis.

The task force, whose members include banks, funds and industry associations, aims to strengthen the market in order to limit its role in any future financial crisis.

At the center of discussions has been the idea of establishing a central clearing system -- which Fed Chairman Ben Bernanke in March suggested considering -- or passing some transactions currently conducted via tri-party repo to utilities such as the Fixed Income Clearing Corporation.

The task force said these issues, among others, are still under consideration and it is analyzing how various new initiatives and proposals might hold up in stressed market conditions.

DRAFT RECOMMENDATIONS

The task force said it is broadly in agreement on several issues, including the need for strengthening collateral margin practices, which could mean higher margin requirements for some counterparties.

Among other draft recommendations, the task force said it agreed to develop a plan to handle a dealer default, and it agreed to do more to improve the transparency of securities collateral prices.

The group has also agreed to make operational improvements that would cut the size of the total exposure taken on each day by the two tri-party clearing banks, but it still needs to work out details of these operational changes.

"The Fed wants to see intraday credit reduced because it's a very large systemic risk and there seems to be broad consensus on this," explained Joseph Abate, money market strategist at Barclays Capital in New York.

The task force said it will also consider limiting the securities that can be accepted in the tri-party repo market and establishing an agent that would be responsible for liquidating a dealer's collateral in the event the dealer fails.

"There's less consensus over other issues that are still under consideration, including what collateral would be eligible in tri-party repo and how you would establish a liquidation agent in the event of a dealer going out of business," said Abate. "There are a lot more difficult questions left to be answered," he added.

The repo market is on life support after the Federal Reserve created an emergency lending facility to stabilize it. That facility will end in February, and dealers are keen to fix the tri-party repo market by then.

The task force said it plans to finish its work and issue final recommendations by the end of the first quarter. The Federal Reserve will then incorporate the results in a white paper for public comment, the group said.

Spokesmen for BNY Mellon and JPMorgan declined comment. (Reporting by Elinor Comlay; Editing by Kenneth Barry)

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