March 7, 2012 / 10:20 PM / 7 years ago

MONEY MARKETS-Tri-party repo risk stirs debate

* Role of high-risk collateral discussed
    * More transparency viewed as desirable

    By Ellen Freilich	
    NEW YORK, March 7(Reuters) - Risk in a market that is
a key funding source for large securities dealers has recently
prompted some debate after a study said the amount of
higher-risk paper pledged in repo transactions had risen to
pre-financial crisis heights.	
    A repo, or repurchase agreement, is a sale of a security
coupled with an agreement to repurchase the security at a
specified price at a later date.	
    In the tri-party repo market, the three participants are the
cash lenders, the cash borrowers, and the tri-party agent who
facilitates the transactions.	
    In the United States, cash lenders are made up mainly of
mutual funds, custodial banks and other asset managers. Cash
borrowers are typically fixed income securities broker dealers
with securities that can be used as collateral. The tri-party
agent is one of two government securities clearing banks. 	
    The large securities dealers depend on the tri-party repo
market for the bulk of their short-term funding, while cash
investors, such as money market mutual funds, count on it to be
a very safe short-term investment. 	
    After the financial crisis exposed the vulnerabilities of
the tri-party repo market's infrastructure, a task force was
formed under the auspices of the Payments Risk Committee, a
private sector body sponsored by the Federal Reserve Bank of New
York. The group's final report, released last month, described
numerous recommendations and the degree of their implementation
- all intended to address potential systemic risk concerns. 	
    Against that backdrop, a study by Fitch Ratings rang an
alarm, asserting the amount of higher risk "structured finance"
paper pledged in repo transactions had risen as a portion of the
overall collateral mix and returned to pre-crisis levels. 	
    Last week the Liberty Street Economics blog - published on
the New York Fed's website but not necessarily reflecting the
position of either the New York Fed or the Federal Reserve
System -  said the content of the Fitch seemed "worrisome" at
first glance. 	
    But public data from the Tri-Party Repo Infrastructure
Reform Task Force reveal "no evidence of a broad-based increase
in riskier types of collateral," wrote Antoine Martin, an
economist at the New York Fed, on the  Liberty Street blog. 	
    The data represent 100 percent of the market's volume, while
the Fitch study was based on data from a sample of prime funds,
representing just 5 percent of the market's size. Prime funds
invest in a diversified portfolio of high quality, short-term,
U.S. dollar-denominated money market instruments. 	
    The Fitch study found a gradual increase in the share of
riskier collateral financed through repos, in particular a big
increase in the share of "structured finance" collateral - a
type of collateral that had almost completely disappeared from
the market during the financial crisis. 	
    Since the monthly data provided by the task force has only
been published since May 2010, it does not allow comparisons
with market dynamics in place before or during the financial
crisis, but it makes it possible to look at recent trends,
Martin wrote in his blog. 	
    Separating safer collateral (securities issued by the U.S.
government or by government-sponsored enterprises) from riskier
collateral (securities not issued by these institutions) shows
the share of riskier assets serving as collateral in the
tri-party repo market has decreased since mid-2011, Martin said.	
    The amount of riskier assets like equities, corporate bonds
and structured finance being financed in the tri-party repo
market has also been decreasing slightly, he said. 	
    Meanwhile, median "haircuts" - the difference between the
value of the collateral and the amount of cash received against
it in a repo transaction - have been roughly flat, Martin said,
with the exception of haircuts for structured products, which
have recently increased.	
    Responding to the Liberty Street blog, Fitch said it had
based its conclusions on Securities and Exchange Commission data
on money funds but remarked on the "excellent high-level
overview" provided by the New York Fed data, which benefited
from timeliness and frequency. 	
    "Either way, the greater transparency afforded by both the
FRBNY and SEC disclosures enhances the market's understanding of
risk trends in this critical funding market," Fitch said. 	
    Joseph Abate, market analyst at Barclays Capital in New
York, said the mixture of tri-party repo collateral does not
appear to have changed significantly since 2010, but there could
be a change in the mix of funders. 	
    "In a search for higher yield, prime funds may be
reallocating their repo transactions away from government paper
toward structured finance collateral," he said. 	
    Prime funds boosted their share of repo allocations to 16
percent by December from 12 percent last spring, he noted. 	
    But if prime funds are increasing their structured finance
repo and the total volume of paper being financed is unchanged,
then another repo market cash provider must be lowering its
exposure to this collateral type, Abate said. 	
    Who that cash provider might be is hard to figure out
because money market funds are not the only cash lenders in the
repo markets, he said. 	
    Securities lenders, insurance companies, and others are
important sources of collateral financing but unlike the money
funds, data on their holdings "are not reported on a granular or
frequent basis. 	
    "Indeed, as noted by others, this is a reason for expanding
data collection in this market," Abate said.
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