Fitch: Fed Repo Facility May Alter Dealers' ST Funding Dynamics

Wed Apr 30, 2014 10:14am EDT

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(The following statement was released by the rating agency) NEW YORK, April 30 (Fitch) The Federal Reserve's reverse repurchase (repo) facility could alter short-term funding dynamics if it grows in size and becomes a more permanent source of short-term money market supply, according to Fitch Ratings. It could alter the funding dynamics between money market funds looking to invest on a short-term secured basis, and broker-dealers and other repo counterparties seeking to efficiently fund the more liquid portions of their balance sheets. These dynamics are neutral to broker-dealer ratings and positive for money market fund ratings. Although the Fed facility could potentially consume a portion of funding undertaken by broker-dealers, it would also reduce the need for broker-dealers to utilize their balance sheets in order to facilitate repo funding on behalf of their clients. Furthermore, broker-dealers are increasingly rationalizing their use of repo funding given the regulatory capital and liquidity requirements associated with the activity. For example, the final supplementary leverage ratio rule approved by U.S. banking regulators earlier this month is likely to dampen repo activity for broker-dealers that are part of large banking entities. Media reports suggest that the SEC is also considering leverage rules for brokers, so a broader group of dealers may also be affected. Regulatory constraints on bank trading activities, including both the Volcker Rule and Basel, could further reduce dealers' need for repo funding and their appetite for providing repo intermediation services. Basel III liquidity requirements also discourage dealers from relying on wholesale short-term funding, such as repos. Although dealers may reduce their repo activity, it will remain an important source of short-term funding. If the Fed's program becomes permanent and allows full allotment, we believe money funds will increase their reliance on the facility at the expense of existing funding relationships with dealers, given the credit quality of the Fed as a repo counterparty and the competitiveness of the rates offered. The extent of the impact for dealers will depend on the amount of funding available under the Fed facility and whether collateral eligibility is extended beyond Treasuries to agency mortgage-backed securities. We believe it will remain important for broker-dealers to maintain a degree of access to repo funding as an efficient means of financing more liquid portions of their balance sheet and to service key clients. This may require broker-dealers to offer more competitive repo rates relative to what is offered by the Fed facility. For money market funds, the Fed repo facility is viewed positively, as it provides additional short-term investment supply at a time of relative scarcity while potentially driving higher offered repo rates. That the exposure is to a more highly rated counterparty, relative to broker-dealer counterparties, further strengthens the attractiveness of the investment opportunity. The Fed's repo facility was established in 2013 as a potential monetary policy tool, but it has also had a secondary effect of providing high quality short-term investment supply to investors such as money market funds. Usage of the facility has been consistently increasing since its inception last year, reaching a record level of $242 billion at the end of first-quarter 2014, and representing 10% and 7% of U.S. government and prime money fund assets, respectively. The facility size may rise further as the Fed has continuously increased the counterparty bid limit, most recently to $10 billion on April 7, from $500 million at the program's inception. Contact: Tara Kriss Senior Director Financial Institutions +1 212 908-0369 Greg Fayvilevich Director Fund and Asset Management +1 212 908-9151 Cynthia Chan Senior Director Fitch Wire +44 20 3530 1655 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at All opinions expressed are those of Fitch Ratings. Applicable Criteria and Related Research: U.S. Money Market Funds Dashboard 4Q13 here Repos: Market Decline Amid Policy Risk here 2014 Outlook: U.S. Securities Firms (Capital and Liquidity Counterbalance Challenging Market Conditions) here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.