April 7, 2010 / 6:01 PM / in 9 years

NY Fed to entice market funds into reverse repos

* Put contract helps money funds comply with SEC rules

* Could attract more participation in reverse repos

By Emily Flitter

NEW YORK, April 7 (Reuters) - The Federal Reserve Bank of New York is planning to include a feature in one of its liquidity-draining schemes that would allow money-market funds to participate without running afoul of new liquidity rules, a fund manager told Reuters on Wednesday.

The New York Fed, which is planning to try to drain cash from the financial markets through reverse repurchase agreements with a variety of counterparties, will include a seven-day put agreement alongside its contracts with money-market funds, said Deborah Cunningham, executive vice president and chief investment officer at Federated Investors in Pittsburgh.

“I think it’s a positive that the New York Fed is undertaking to potentially do reverse repos with non-traditional counterparties,” Cunningham said. “They’re going down the path of confirming how that will occur.”

The seven-day put would allow funds to liquidate their repo holdings and retrieve cash quickly in the event of an emergency. It would also let money market funds classify their repo agreements with the Fed as short-term cash investments under a new set of rules the Securities and Exchange Commission implemented earlier this year.

“It would be extremely helpful in attracting participation and limiting the impact of the operations on broader money market conditions,” said Lou Crandall, chief economist at Wrightson ICAP in New York.

“Money funds need liquidity options,” Crandall added. “Money funds have always needed a liquidity option, but that need has become even more acute with the stringent liquidity rules imposed by the SEC this year.”

In February, the SEC changed the rules governing money-market funds that forced funds to keep more of their holdings in cash investments that could be liquidated immediately. The rule change came after money-market funds found themselves besieged by demands for cash during the height of the financial crisis. Many were unable to liquidate their holdings quickly enough to meet redemptions.

The Fed’s reverse repo plans are part of its larger strategy to drain some of the excess liquidity with which it flooded the financial markets to combat the crisis in late 2008 and early 2009. The Fed has said it is also exploring other options, including paying interest on reserves, as a way to take cash out of the system.

The New York Fed did not respond to a phone message requesting comment for this story. (Editing by Padraic Cassidy)

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