Economists at the Federal Reserve Bank of New York recently wrote on their new "Liberty Street Economics blog, "Everything You Wanted to Know about the Tri-Party Repo Market, but Didn't Know to Ask." It says, "The tri-party repo market is a large and important market where securities dealers find short-term funding for a substantial portion of their own and their clients' assets. The Task Force on Tri-Party Repo Infrastructure (Task Force) noted in its report that 'at several points during the financial crisis of 2007-2009, the tri-party repo market took on particular importance in relation to the failures and near-failures of Countrywide Securities, Bear Stearns, and Lehman Brothers.' In this post, we provide an overview of this market and discuss several reforms currently under way designed to improve functioning of the market. A recent New York Fed staff report provides an in-depth description of the market."
The post asks, "What Is the Tri-Party Repo Market? It answers, "The tri-party repo market is one where securities dealers fund their portfolio of securities through repurchase agreements, or repos. A repo is a financial transaction in which one party sells an asset to another party with a promise to repurchase the asset at a pre-specified later date. A repo resembles a collateralized loan but its treatment under bankruptcy laws is more beneficial to cash investors: in the event of bankruptcy, repo investors can typically sell their collateral, rather than be subject to an automatic stay, as would be the case for a collateralized loan. In the tri-party repo market, a third party called a clearing bank acts as an intermediary and alleviates the administrative burden between two parties engaging in a repo."
The piece also asks, "Why Should We Care about the Tri-Party Repo Market? It answers, "The importance of this market was highlighted by the recent financial crisis. As noted above, the tri-party repo market took on particular importance in relation to the failures and near-failures of Countrywide Securities, Bear Stearns, and Lehman Brothers. 'The potential for the tri-party repo market to cease functioning, with impacts to securities firms, money market mutual funds, major banks involved in payment and settlements globally, and even to the liquidity of the U.S. Treasury and Agency securities, has been cited by policy makers as a key concern behind aggressive interventions to contain the financial crisis,' according to the Task Force Report."
The economist explain, "The tri-party repo market is very large. At its peak in 2008, about $2.8 trillion of securities were funded by tri-party repos. Volumes shrank to $1.6 trillion in the second half of the financial crisis, and have been steady around that level since. The size of individual portfolios being financed in this market is also very large. At the peak, some dealers were financing portfolios of $450 billion in the tri-party repo market, mostly overnight."
They also say, "The tri-party repo market is made up of three types of participants: securities dealers, cash investors, and clearing banks that function as intermediaries between dealers and investors. The dealers sell securities with a promise to repurchase these securities at a later date.... The largest dealers in the tri-party repo market are primary dealers.... The cash investors buy securities that they will sell back at a later date.... Money market mutual funds and securities lenders are the two largest groups of cash investors, each representing about a quarter of the cash invested in that market.... The two tri-party repo clearing banks in the United States are JPMorgan Chase and Bank of New York Mellon."
The post also asks, "How Are Reforms Improving the Market? It says, "The financial crisis highlighted some problems with the tri-party repo market. A white paper prepared by the New York Fed describes how this market may contribute to systemic risk. The white paper mentions three key areas of concern: 1) the tri-party repo market's dependence on intraday credit provided by the clearing banks, 2) risk management practices that may increase stress in bad times, and 3) the lack of effective 'and transparent plans to support orderly liquidation of a defaulted dealers collateral."
Finally, the blog says, "In the next few months, the tri-party repo market will change in important ways as the recommendations of the Task Force are implemented. It will be interesting to see how the market adapts to new ways of doing things and what reforms are enacted to increase the stability of the tri-party repo market regarding dealer defaults. While the Task Force has accomplished quite a bit, more needs to be done to address the risk associated with the default of a large dealer."
