The U.S. Treasury's OFR issued a press release entitled, "Office of Financial Research Reports on Risks to Financial Stability," which tells us that, "Overall risks to financial stability remain moderate, similar to a year ago, the U.S. Office of Financial Research said in releasing its 2017 Annual Report to Congress and 2017 Financial Stability Report today." Retiring OFR Director Richard Berner says, "We assess threats to financial stability by weighing vulnerabilities in the financial system against its resilience." While money funds, repos and 'shadow banking' weren't major topics like in last year's update, there were a few mentions. We review the reports below. (See also Crane Data's Dec. 14, 2016 News, "Report Shows OFR Still Focused on Shadow Banking, Money Funds, Pools," and our July 21, 2016 News, "OFR Introduces Money Market Fund Monitor.")
The release explains, "As required by the Dodd-Frank Act, the 2017 Annual Report to Congress assesses the state of the United States financial system, including: analysis of threats to the financial stability of the United States, key findings from the OFR's research and analysis of the financial system, and the status of the efforts of the OFR in meeting its mission, including how the OFR supports the Financial Stability Oversight Council, or FSOC, and other key stakeholders."
One of the key findings in the report involves a "LIBOR Alternative." They tell us, "Alternatives to LIBOR are needed. LIBOR is an interest rate benchmark, formerly the London Interbank Offered Rate and now ICE LIBOR (Intercontinental Exchange LIBOR). Among the many steps needed to achieve a smooth transition to these alternatives, officials and market participants must help develop active derivatives markets that use the new rate."
The OFR's "2017 Annual Report to Congress" mentions, "In collaboration with the Federal Reserve, we advanced plans to begin collecting data on bilateral repurchase agreements and to publish new reference rates that are alternatives to LIBOR."
The paper examines vulnerabilities that arise from "structural changes in markets and industry." Among the structural changes the OFR is watching, one is "the danger of a difficult transition to a new reference rate to replace the London Interbank Offered Rate (LIBOR)." They also say, "A lack of substitutability is an aspect of market structure that can pose a threat.... For example, the increasing reliance on a single institution for settlement of Treasury securities and related repurchase agreements (repos) is a key vulnerability. An interruption in Treasury settlement services would disrupt the Treasury market and potentially a range of other markets."
It continues, "Another potential threat comes from the transition from LIBOR to an alternative. The risks and costs of using LIBOR make the move essential, but failure to make a timely and smooth transition could impair the functioning of markets that now rely on LIBOR. LIBOR reflects transactions in a shrinking market. Most of the responses by traders to the LIBOR survey are based on judgment rather than actual trades. LIBOR tracks unsecured transactions, which represent a small share of banks' wholesale funding."
The OFR also says, "The new U.S. benchmark rate, the Secured Overnight Financing Rate, will be produced by the Federal Reserve Bank of New York in cooperation with the OFR. It will be based on trading activity in repos backed by Treasury securities, not bank surveys.... The OFR joined the effort, and [they] have worked closely with the Federal Reserve to create a set of benchmarks based on data on overnight repurchase agreements, or repos. The Federal Reserve Board and the Federal Reserve Bank of New York convened the Alternative Reference Rates Committee, made up of banks active in the derivatives market, to inform the process."
They explains, "The repo market is a key source of secured short-term funding for the financial system. In a repo transaction, a security owner sells a security to raise cash. The agreement requires the seller of the security to repurchase it on a specific date for a prearranged price. If the seller is unable to repurchase the security, the cash provider is entitled to liquidate the security for repayment."
The OFR writes, "In late August 2017, the Federal Reserve sought public comment on three daily rates based on repo transactions with U.S. Treasury securities that would be published by the Federal Reserve Bank of New York in cooperation with the OFR.... The Alternative Reference Rates Committee selected the Secured Overnight Financing Rate in June 2017 as its preferred alternative to U.S. dollar LIBOR. The new benchmarks would be more reliable and viable than LIBOR because they are based on actual secured transactions, rather than quotes, and would bring necessary transparency to the repo market."
They also say, "During fiscal year 2017, we improved our U.S. Money Market Fund Monitor, which tracks the investment portfolios of money market funds and shows trends and developments across the money market fund industry. The monitor uses data converted from the SEC Form N-MFP and presents the information in a graphic, user-friendly format on the OFR website. It makes the underlying data freely available for download by the industry and public for monitoring and analysis. The monitor is one of the most viewed items on the OFR website, with more than 14,000 page views in the year after its launch."
They explain, "Our pilot work to collect and anonymize repo data to produce reports about the bilateral repo market has been widely cited by market participants as a success. In addition, the industry Alternative Reference Rates Committee has expressed support for the repo-based reference rate (to replace LIBOR) that the OFR and the Federal Reserve Bank of New York would produce."
Finally, the OFR comments, "In FY 2018, we plan to undertake a rulemaking to establish an ongoing data collection covering some repo transactions. These data might be useful in calculating the selected LIBOR alternative, called the Secured Overnight Financing Rate."
