Measuring money... faster, cheaper, cleaner

We learned from a J.P. Morgan Securities "Short-Term Fixed Income Research Note" released last night that the Task Force on Tri-Party Repo Infrastructure Payments Risk Committee just issued a Progress Report. The report says, "The Task Force on Tri-Party Repo Infrastructure was formed in September 2009 under the auspices of the Payments Risk Committee, a private sector body sponsored by the Federal Reserve Bank of New York.... The Task Force's objective is to develop a set of recommendations for improving and mitigating risks related to triparty repo transactions, given the important role such transactions play in supporting the liquidity and efficiency of U.S. securities markets and in the implementation of monetary policy. The primary areas of focus for this effort are clearance and settlement arrangements, credit and liquidity risk management practices and tools, and arrangements for facilitating the orderly disposition of collateral in stress scenarios."

The Progress Report says, "Through its recommendations, the Task Force seeks solutions intended to assure the Federal Reserve and other key stakeholders that tri-party repo arrangements will not amplify systemic credit and liquidity risks during potential future market disruptions.... The Task Force is confident that a ... strengthening of tri-party repo arrangements will be achieved and that these arrangements will continue to contribute importantly to the liquidity of U.S. government and other securities markets. The Task Force membership includes representatives from the two tri-party clearing banks, collateral providers including banks and securities dealers, cash investors that are counterparties to collateral providers (including custodians/asset managers, hedge funds, and money market mutual funds), DTCC, and industry associations (SIFMA, ICI, MFA)."

J.P. Morgan Securities' Research Note, entitled, "Is the tri-party over? Changes coming to the repo market," says, "Over the past 25 years, tri-party repo has evolved into a large and systemically important market, one that figured prominently in the 2008 market turmoil. Repurchase agreements are a form of secured lending and are typically understood as a bi-lateral transaction where one party agrees to sell an asset and repurchase the same asset at a higher price at a later date. In practice, most of the repo market relies on tri-party arrangements where a custodian bank stands between borrowers (seller) and lenders (buyer). The custodian bank manages the settlement risk, clears trades, provides valuation, and position reporting."

The Report continues, "With hindsight, several important lessons emerge with regard to secured funding generally: Dealer liquidity contingency plans in many cases did not adequately consider the potential for a broad pull-back in repo financing or an abrupt change in the terms of that financing; Cash investors might have had difficulty managing the risks associated with a dealer default in which they needed to liquidate large portfolios of repo collateral simultaneously; Margin levels received by repo cash investors in certain asset classes became inadequate; and, Market participants did not sufficiently anticipate the potential for some types of repo collateral to lose price transparency and liquidity for extended periods of time."

It adds, "On a number of aspects, a broad consensus is emerging. These include the following: Implement multiple operational improvements to substantially reduce the size of the daily unwind and therefore the size of the intraday secured exposures taken on by the clearing banks; Strengthen collateral margining practices; Enhance liquidity risk management practices; Identify sound practices for contingency planning by tri-party repo cash investors for a possible dealer default; and, Improve the transparency of the tri-party repo market."

Finally, the report concludes, "The Task Force, in conjunction with the Federal Reserve, will sponsor an outreach workshop with a broad set of market participants beyond those directly involved with the Task Force in early 2010. Given the urgency of its mission, the Task Force intends to conclude its work and issue its report and recommendations by the end of Q1 2010. The Federal Reserve is expected to incorporate the results in a white paper that will be issued for public comment."

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