Updated June 18, 2012
RepoWatch recommends the following reports.
Search for the topics that interest you: DataWatch, International repo market, Money market funds, Regulation, Repurchase transactions, Securitization, Shadow banking, Too big to fail, and Tri-party repo. Items are arranged chronologically, within topics that are listed alphabetically.
DataWatch
“3-Tier System Recommended for Issuing Global Identifiers” by Tom Steinert-Threlkeld, Securities Technology Monitor, June 8:
The Financial Stability Board will recommend to the G-20 industrial nations that a three-tier structure involving local registration authorities be established for registering and issuing 20-character codes that will identify participants in financial transactions, worldwide. …
A central database of the identifiers is seen as fundamental to helping regulators watch for risks to the global financial system. A 20-character code has been set out as the basis for the code, known as a Legal Entity Identifier, by the International Organization for Standardization; and, backed by the FSB, which has been established to coordinate at the international level the work of national financial authorities and international standard setting bodies. …
A number of different technology and communications organizations are expected to vie to operate the Central Operating Unit.
“A Global Legal Entity Identifier for Financial Markets” by the Financial Stability Board, June 8:
The FSB strongly supports rapid implementation of the global LEI system. Early delivery of the system would advance multiple G-20 financial market initiatives and benefits to the global regulatory community as well as to the private sector.
The FSB recommends adoption of an implementation plan with the goal of establishing an independent, open, fair and transparent global LEI system by the end of 2012 with the system independently functional by March 2013. …
The attached report sets out the recommendations and implementation plan.
International repo market
“In Europe, Banks Borrowing to Stay Ahead of the Tide,” news analysis by Landon Thomas Jr., The New York Times, June 10, 2012:
At the root of the issue is a simple fact: just like the countries in which they operate, most European banks are highly leveraged entities. They are heavily dependent on borrowed money to operate day to day, whether making loans or paying interest to depositors.
For decades, the loans that European banks made to individuals, corporations and their own spendthrift governments far exceeded the deposits they were able to collect — the money that typically serves as a bank’s main source of ready funds. To plug this funding gap, which analysts estimate to be about 1.3 trillion euros, European banks borrowed heavily from foreign banks and money market funds. That is why European banks have an average loan-to-deposit ratio exceeding 110 percent — meaning that on any given day, they owe more money than they have on hand.
Money Market Funds
“Liquidity in European Money Market Funds – Structural Improvement But at a Cost” by Charlotte Quiniou, Alastair Sewell, and Richard Woodrow, Fitch Raings, May 2012:
European Money Market Funds have improved their liquidity profile following the 2008 crisis and the subsequent amendments to regulation and rating agencies’ guidelines. This improved liquidity acts as a buffer to the volatility in investors’ flows. It nevertheless comes at an opportunity cost for those investors who have part of their foreseeable liquidity needs with relatively longer term horizons and therefore do not take full advantage of the liquidity mutualisation offered by short-term MMFs. …
All else being equal, highly liquid portfolios will have lower yields than less liquid ones. Maintaining a high degree of liquidity costs about 20bp to 30bp of yield to a fund …
Regulation
“U.S. Moves Forward on Implementing Global Bank Rules” by Yalman Onaran and Jesse Hamilton, Bloomberg News, June 8:
The Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency yesterday published a revised version of rules that were decided in 2009, dictating for instance how much capital banks need to back mortgage-linked securities. The regulators also proposed another set of rules that will translate for U.S. lenders a more fundamental overhaul of the capital regime drawn up by the Basel Committee on Banking Supervision in 2010.
Each Basel committee nation must write rules comporting with the decisions of the 27-member body, and the 2009 revisions were supposed to take effect last year. U.S. regulators were delayed as they merged the Basel regime with the 2010 Dodd-Frank Act and had been criticized by the European Union for falling behind. …
The Fed estimated the banking industry would face a capital shortfall of almost $60 billion if the proposed capital buffers of Basel III were in effect today. That compares with a Basel committee survey’s finding that the largest global banks would confront a $639.5 billion shortfall if forced to have a 7 percent core capital buffer last year. The regulators anticipate U.S. banks could meet their 2019 requirement by retaining earnings rather than raising capital.
“Protecting citizens from bank failures” by the European Commission, June 6:
The global financial crisis has demonstrated that a problem with one bank can quickly spread to the rest of the economy and to other countries. It has also become clear that EU countries don’t have the right rules in place to properly manage failing banks.
In many cases EU governments have had to spend taxpayers’ money to shore up some of the bigger banks and prevent harm to millions of customers and the financial system.
To fill in the gap, the Commission is proposing a common framework of rules to help EU countries and national regulators respond quickly and effectively to a banking crisis.
The measures would also help reduce the impact a bank failure could have on the stability of the financial markets, and limit the cost to taxpayers if a bailout became necessary.
They would shift the burden of restructuring costs and responsibility to the bank’s shareholders, creditors and any employees responsible for mismanagement.
See the Financial Times’ report on the European Commission’s proposed framework here.
“Artfully Dodging the Liquidity Coverage Ratio in Securities Lending and Repo” by Securities Finance Monitor, May 29:
Banks everywhere are focusing on the Liquidity Coverage Ratio provisions in Basel III. The provisions don’t kick in until 2015, but the observation period is in full swing and no one wants to tell their management that they missed the target.
The epicenter of the ratio at many institutions is the repo business. They can best manage the measurement and control the flows.
And, it wouldn’t be the finance sector if a number of tricks innovations hadn’t emerged to soften the blow.
Repurchase Transactions
“Moody’s Reviews Push Funds Away From Other Repo, Says JP Morgan” by Crane Data, June 11:
As of this writing, Moody’s has yet to conclude its ratings review of Global Capital Market’s Institutions and to many money market participants, this is the main event as these institutions are often the largest borrowers in the money markets, particularly through the repo market.
According to our estimates using money market fund holdings data (including government money market funds), Global Capital Market’s Institutions counterparties represented about $510 billion or 89 percent of total repo held by money market funds.
“MF Global caught up in deals tangle” by Tracy Alloway, Financial Times, June 5:
When an industry taskforce set up by the Federal Reserve decided last year to reduce the window in which short-term “repo” trades were unwound it hoped to reduce risk in the financial system.
Instead, it might have helped push MF Global, the ill-starred broker-dealer, closer to collapse, according to a report by the bankruptcy trustee released on Monday….
The tangle of repo transactions, in the words of one unnamed MF Global executive, helped lead to a “liquidity asphyxiation” which overwhelmed the broker-dealer.
“The run on MF Global: Report of the Trustee’s Investigation and Recommendations,” bankruptcy of MF Global Inc., by trustee James W. Giddens, June 4, 2012:
Want to see what a run on repo looks like from the inside?
On October 24, Moody’s Investors Service downgraded MF Global’s credit rating to near-junk status. Then, on October 25, MF Global held its third quarter earnings call during which it announced the $119 million write-off of deferred tax assets, signaling increased doubt about near-term prospects for profitability. The next day, S&P put MF Global on “Credit Watch Negative,” and on October 27, Moody’s cut MF Global to junk status. Together with the downgrades of MF Global’s credit rating and growing concerns about the large sovereign debt portfolio, this news contributed to a major loss of market confidence.
A classic run on the bank ensued as customers sought to withdraw their property from their MF Global Inc. accounts, while counterparties and exchanges demanded increased collateral or margin. At the same time, other counterparties declined to do business with MF Global altogether, leaving it with illiquid securities that it could not finance in the repo market or elsewhere. The rush to meet funding needs for collateral, margin and customer liquidations led to billions of dollars in securities sales, draws on credit facilities, and a web of inter-company transactions across MF Global affiliates. MF Global’s computer systems and employees had difficulty keeping up with the unprecedented volume of transactions. Some transactions were recorded erroneously or not at all. So-called “fail” transactions, where either the buyer or seller failed to deliver the cash or the security, respectively, were more than five times greater than the normal volume that week. It was, in the words of one former MF Global executive, a “liquidity asphyxiation.” …
Management estimated a loss of approximately $1 billion over the course of three to four weeks. Instead, a loss of at least one and one half times that amount occurred in a matter of a few days. The simultaneous occurrence of a customer “run on the bank” and unwinds of repo counterparty and proprietary positions within a three-day timeframe overwhelmed the Firm.
The mitigating factors were also overly optimistic. The speed at which events transpired was beyond management’s predictions – the worst-case scenario played out in the span of only a few days. Reality unfolded vastly more quickly than the assumptions and timing laid out in the presentation, which anticipated that MF Global had sufficient liquidity to survive a “severe stress event” for at least one month.
An example of the financial interconnectedness of a securities dealer’s affiliates:
The reto-to-maturity structure was as follows. MF Global UK purchased the sovereign bonds from counterparties, the trades for which settled on the LCH (clearing house). MF Global UK then sold the bonds to MF Global Inc., although the bonds remained in MF Global UK’s LCH account. MF Global Inc. recorded the bonds on its books, classifying them as securities owned in MF Global Inc.’s long inventory book. Subsequently, MF Global Inc. entered into an intercompany repo with MF Global UK (which showed a reverse repo to MF Global Inc.). Each intercompany repo was governed by the global master repurchase agreement between MF Global UK and MF Global Inc. dated July 19, 2004, as amended. On completion of the repo-to-maturity with MF Global Inc., MF Global UK entered into a further repo-to-maturity with another counterparty that also settled through the LCH.
(Update: New York Times columnist Floyd Norris gives a superior explanation of MF Global accounting, based on the Giddens report. See “Accounting Backfired at MF Global,” June 7.)
A different bankruptcy trustee, for MF Global’s holding company, issued his own detailed report June 4. It focuses on technical aspects of the case and spends less time explaining MF Global operations.
“The Eurepo curve spells trouble” by Simon Hinrichsen, Financial Times, Alphaville blog, May 29:
Sandy Chen at Cenkos has drawn our attention to an interesting development in the repo market: the Eurepo curve has inverted….
As Sober Look noted on Friday, inverted repo curves mean stress in the market, and looking at the shift in the Eurepo curve in the last month, the level of stress has gone up considerably…
“The repo market awaits” by Greg Canavan, The Daily Reckoning, May 24:
You can take comfort in the knowledge that this global mess we call a financial system is all about the banks. Successive Greek bailouts (not to mention Ireland and Portugal) were about protecting undercapitalised and essentially insolvent banks.
We’re not exactly breaking news here. But we feel we must continue to shout into the wind and maintain that this slow motion implosion of the global economy is all about the banks. …
If you think that’s overstating the issues, just give it time…you’ll see what we mean.
Because while you’re focusing on Greece or China or something else tangible, the real danger lies where you can’t see. It’s deep in the plumbing of the financial system…the repo market and derivatives. We’re convinced that the next blow-up will come from deep within the bowels of the financial system.
Securitization
“Securitisation market seeks SP clearing carve” by Risk.net, June 12:
The International Swaps and Derivatives Association said the cost of securitisation likely will increase unless special-purpose vehicles receive an exemption for clearing swaps they transact. Some regulators have said reviving the securitisation market could help stabilise the banking industry. “If SPVs are required to clear, it would make them a whole lot less viable,” said Richard Metcalfe, global head of policy at ISDA in London. “You would have to add the cost of posting margin and other clearing costs. You could add that cost to the client, but it has to come out of somebody’s pocket.” (Summary provided by the Global Financial Markets Association’s SmartBriefs.)
“European ABS industry looks to rebrand” by Mary Watkins, Financial Times, June 12:
Europe’s securitisation industry has officially launched a new labelling system that aims to revive the fortunes of a financial product that some dubbed as toxic during the US subprime crisis.
The Prime Collateralised Securities project will award a stamp of approval to high quality European asset backed securities that meet a set of criteria in terms of quality, transparency, simplicity and standardisation.
“Regulators may intervene in securitised market” by Huw Jones, Reuters, June 7:
Global regulators may intervene and iron out differences in how the United States and European Union have cracked down on lax underwriting of securitised debt, as the market shows little sign of a real revival to help fragile banks.
The International Organisation of Securities Commissions (IOSCO) said in a report for public consultation on Thursday that securitization was a valuable funding technique and an efficient means of diversifying risk. …
IOSCO said the EU and U.S. approaches appear similar but the exemptions allowed in the United States for very high quality assets may give it an advantage over Europe….
Few other countries in the world have or plan to introduce retention rules.
“China authorizes loan-backed securities” by Gao Changxin, China Daily, June 4:
China has reopened the gate on loan-backed securities, after suspending a trial in the aftermath of the global financial crisis.
China’s central bank, the People’s Bank of China, has authorized a 50 billion yuan ($7.85 billion) quota for the country’s lenders to securitize their loans. Lenders are required to submit securitization plans for regulatory approval. The quota is expected to be fulfilled by year-end and more quotas are likely to be authorized in the future.
“Afme prepares for launch of securitisation kitemark” by Farah Khalique, Financial News, May 14:
The Association for Financial Markets in Europe is planning to launch its securitisation kitemark scheme, aimed at reviving Europe’s ailing asset-backed securities market, in the third quarter of the year. The Prime Collateralised Securities Initiative will identify products that meet industry best practice criteria and will be granted and maintained by an independent third party.
Shadow banking
“Banks seek to offload risk on insurers” by Lisa Pollack, Financial Times, June 12:
Now when and where did that last happen…
In Tuesday’s Financial Times, Brooke Masters reported on a rather novel approach that some banks are trying to take in order to reduce their capital requirements. The trick is to reduce the predicted loss that would be experienced if a borrower were to default. This is effectively done by getting an insurer to guarantee the future value of the collateral held as security for the loan.
The collateral in question is, however, no ordinary collateral. It’s intangible, like patents, for example….
From this one naturally draws parallels to the monoline insurance companies’ forays into derivatives on US subprime mortgages. It turns out that particular asset class was also rather hard to value correctly — something that only became evident to many in the industry after a systemically risky amount of contracts had been written by the likes of AIG, Ambac, MBIA, and so on.
Indeed FT Alphaville is reminded of the original Fed approval for credit default swaps to reduce regulatory capital — something that the original inventors of the contracts (JPMorgan) had lobbied hard for. That led to many (unforeseen) things…
“Shadow Banking After the Financial Crisis,” a speech by Federal Reserve Board Governor Daniel K. Tarullo, June 12:
Today I want to focus on the development of a regulatory reform agenda for the shadow banking system. As those who have been following the academic and policy debates know, there are significant, ongoing disagreements concerning the roles of various factors contributing to the rapid growth of the shadow banking system, the precise dynamics of the runs in 2007 and 2008, and the relative social utility of some elements of this system. …
However, as it is neither necessary nor wise to await such conclusions in order to begin implementing a regulatory response, I will follow my discussion of the vulnerabilities created by shadow banking with some suggestions for near- and medium-term reforms….
Let me then suggest three more-or-less immediate steps that regulators here and abroad should take, as well as a medium-term reform undertaking.
First, we should create greater transparency with respect to the various transactions and markets that comprise the shadow banking system. For example, large segments of the repo market remain opaque today….
Second, the risk of runs on money market mutual funds should be further reduced through additional measures to address the structural vulnerabilities that have persisted even after the measures taken by the SEC in 2010 to improve the resilience of those funds. …
A third short-term priority is to address the settlement process for triparty repurchase agreements. Some progress has been made since 2008, but clearly more remains to be done.
In the medium term, a broader reform agenda for shadow banking will first need to address the fact that there is little constraint on the use of leverage in some key types of transactions. One proposal is for a system of haircut and margin requirements that would be uniformly applied across a range of markets, including OTC derivatives, repurchase agreements, and securities lending.
“The other fiscal cliff issu(-ance)” by Cardiff Garcia, Alphaville blog, Financial Times, June 8:
Most of the fear of what might happen if the US goes over the proverbial fiscal cliff has concentrated on the size of the economic drag it would produce.
But as you might have guessed for a blog that has long worried about the effects of a decline in safe assets on trust in financial intermediation, shadow banking liquidity, collateral shortfalls in money markets, etc… we also think it’s important to look at what it would mean for the corresponding decline in US Treasury issuance.
“Shadow-Bank Rules A Banking Union Cornerstone, Barnier Says” by Ben Moshinsky, Bloomberg News, June 7:
Proposals on shadow banking and the structure of lenders’ retail and investment arms are priorities this year as the European Union pushes toward a banking union, said Michel Barnier, the bloc’s financial services chief….
The commission “must ensure that the new financial regulation does not push certain banking activities toward the non-regulated sector,” Barnier said. Shadow banking, which includes money-market funds, securitizations and off-balance- sheet investment vehicles, represents as much as 30 percent of the entire financial system, he said.
“Shadow banking not that shadowy, says Cantor” by Securities Finance Monitor, June 4:
Cantor Fitzgerald is starting a repo conduit called Institutional Secured Funding. For those who aren’t familiar with repo conduits, they are classic shadow banking. Traditional repo conduits allow securities dealers to obtain financing for the weird, wonderful and illiquid by repo’ing in those assets and issuing asset-backed commercial paper (ABCP) to fund themselves.
(RepoWatch editor’s note: Here’s a link to the Cantor press release, courtesy of Securities Finance Monitor.)
“Cantor Plans To Enter Shrinking Shadow Banking” by Jody Shenn and Lisa Abramowicz, Bloomberg News, June 1:
Cantor Fitzgerald LP joins a growing number of financial firms offering a new version of asset-backed commercial paper that will be backed by repurchase agreements, thereby turning short-term repos into longer-term ABCP.
Regulations are fueling some ABCP funds, with banks such as JPMorgan Chase & Co. and Barclays Plc setting up conduits to use on their own to convert repurchase-agreement, or repo, borrowing into commercial paper. New York-based Cantor’s fund, known as Institutional Secured Funding, will be open to multiple banks. …
Turning the repo into commercial paper before selling it broadens the types of buyers and makes it easier to trade. Banks also need to find financing with longer maturities amid changing regulations pending under international rules known as the Basel III accord, Roever (Alex Roever, JPMorgan’s head of short-term fixed-income strategy) said….
The assets being placed in the conduit remain on the bank’s balance sheet under accounting rules, as they would with repo agreements with other counterparties, and buyers of the commercial paper see a full list of what they are and at what prices they’re held, he said. Eligible securities include equities, U.S. corporate bonds and convertibles, Fitch said in an October report.
The Deloitte Shadow Banking Index, “Shedding light on banking’s shadows,” Deloitte Center for Financial Services, by John Kocjan, Don Ogilvie, Adam Schneider, and Val Srinivas, May 29, 2012. See press release for summary of this report.
The purpose of the Deloitte Shadow Banking Index is to define and quantify the sector over time, including its components. This ongoing effort is designed to more closely measure size, importance, effect of market, and impact of regulatory actions, as well as a way to assess the potential impact of shadow banking on regulated markets.
Too big to fail
“Derivatives and U.S. Corporations – Six Firms Continue to Dominate as Dodd-Frank Act Lurks” by Olu Sonola, Eileen Fahey, and Brian Yoo, Fitch Ratings, June 7:
Six financial services firms dominate the amount of derivative assets and liabilities carried on the balance sheets of U.S. corporates, according to a Fitch Ratings review of 100 large companies across all major industry groups.
The six firms – JP Morgan Chase & Co., Bank of America Corp., Goldman Sachs Group Inc., Citigroup Inc., Morgan Stanley, and Wells Fargo & Co. – hold an excess of 75% of the total derivative assets and liabilities in the sample reviewed by Fitch. The notional amount of all derivatives held by the 100 companies was approximately $300 trillion at year-end 2011. This has remained steady – between $290-$300 trillion – since 2009.
The notional amount of credit derivatives fell to $21.6 trillion at year-end 2011 from $36 trillion in March 2009, a 40% decline….
The Dodd-Frank Act will significantly chance the regulatory landscape of over-the-counter derivatives for both financial and non-financial firms. Fitch believes that in spite of some end-user exemptions, non-financial firms will experience increased collateral requirements and costs to comply with new regulations.
“If We Can’t Understand Them, We Should Just Break Them Up” by Rep. Brad Miller, Huffington Post, May 24:
I’ve skimmed some informed discussions at economics blogs about how JPMorgan Chase lost $2 billion and counting on their “synthetic credit portfolio.” But educated guesses are still guesses, the next big problem in the financial system will be entirely different, and to be honest, it all gives me a headache. …
So how do we avoid this grim future created by financial practices beyond the ken of lesser mortals like congressmen and regulators?
We can just break the biggest banks up. A bank would almost certainly be easier to understand, both for the bank’s managers and for safety and soundness regulators, if there is less to understand. And if a smaller bank’s management and regulator don’t understand a risk in shadow banking or derivative markets, the risk may bring the bank down, but it probably won’t lead to a “deflationary collapse” of the economy.
There is little that a $2.3 trillion bank can do that ten $230 billion banks can’t do as well or better, and banks the size of JPMC are far more than ten times the problem.
Last week Senator Sherrod Brown and I introduced the SAFE Banking Act to break up the biggest banks into banks that are small enough and simple enough to fail without bringing the financial system down. The biggest banks probably think that’s an infantile idea, and that Americans won’t support that solution to “too big to fail” banks.
Surprise, surprise, surprise.
Tri-party repo
“Disagreeing with Duffie: central US tri-party clearing utility not the right choice right now” by Securities Finance Monitor, June 5:
Two weeks ago we published on Professor Darrell Duffie’s article “Replumbing our Financial System: Uneven Progress.” Since then we’ve given the matter some more thought and want to comment on whether US tri-party repo should be centralized at a government-backed utility work, and would this be better or worse than current market practice. …
Our question is, in whatever form is central clearing for US tri-party repo the right thing to advocate? We think that the answer is no …
RepoWatch 