News Round-up: Role of repo, securitization and shadow banking unsettled in post-crisis world

RepoWatch recommends the following news reports. Items are arranged chronologically, with the most recent coming first.

Fed Said to Press BNY Mellon to Speed Repo Market Change” by Bradley Keoun, Bloomberg News, September 25:

The Federal Reserve, seeking to cut risks in the financial system, is pushing Bank of New York Mellon Corp. (BK) to speed changes in a $1.8 trillion bond-lending market that helped fuel the 2008 crisis.

BNY Mellon, which handles about 80 percent of loans in the so-called triparty repo market, will complete computer upgrades and projects aimed at bolstering the system by 2014, two years earlier than planned, according to a document on its website. The bank had pledged in February to finish the tasks by 2016, prompting the Fed to criticize industry-led reforms as too slow.

Since then, the Fed has used its supervisory powers to get quicker results, said three people with knowledge of the matter, who requested anonymity because the talks are confidential. JPMorgan Chase & Co. (JPM), which clears the rest of triparty repo trades, previously agreed to complete reforms before 2014. The upgrades would make the market less prone to the panics that destroyed Bear Stearns Cos. in 2008 and triggered a $148 billion Fed bailout program to keep other brokerages from collapsing.

“The Fed continues to view repo as an outstanding risk,” said Josh Galper, a former Merrill Lynch & Co. executive who’s now managing principal of Finadium LLC, a securities-lending consultant in Concord, Massachusetts. “So they have made it clear that they want the process to move faster.”

BNP Paribus: How to save European securitisation” by Lucy McNulty, International Finance Law Review, September 25:

The first Prime European Collateralized Securities labeled securitisation is expected imminently.

The PCS Initiative was launched by the Association for Financial Markets in Europe and the European Financial Services Roundtable in June.

It aims to revive the region’s depressed securitisation market by developing a label for high-quality securitisations.

Do government SIFI liquidation programs make bank or CCP counterparties safer?” by Josh Galper, Securities Finance Monitor, September 17:

Recently the question has come up about which are less risky in today’s financial environment: bilateral counterparties or central counterparty clearing houses (CCPs). Both have their own pros and cons, and it is well known (to the industry, if not to regulators) that CCPs do not minimize or eliminate risk, they just spread it around differently. We are finding that there is a piece missing to the question, which is, “what is the risk now that banks and CCPs may be deemed Significant Financial Counterparties (SIFIs) and have implicit or explicit government guarantees?”

ECB to Set Up Repo Database as EU Moves to Rein in Shadow Banks” by Rebecca Christie and Jim Brunsden, Bloomberg News, September 17:

The European Central Bank plans to boost oversight of trading in repurchase agreements by setting up a transactions database amid a push by regulators to rein in so-called shadow banking, a European Union document shows.

Highlights of Bank of England comments on collateral and collateral transformations” by Josh Galper, Securities Finance Monitor, September 14:

The Bank of England released their quarterly bulletin yesterday with some interesting survey comments on collateral management and collateral transformation. …

“Contacts reported that financial market participants were managing the increased need for collateral in a number of ways. These include (i) managing collateral more efficiently; (ii) using so-called ‘collateral transformation services’; and (iii) loosening collateral criteria.”

Conduit to Fund Guggenheim Repo Deals” by Asset-Backed Alert, September 14:

The former Liberty Hampshire has set up a commercial-paper conduit with some unusual twists.   The operation, which has gone by Guggenheim Treasury Services since early 2011, launched the vehicle Sept. 10 under the name Ridgefield Funding.

It has since placed more than $600 million of short-term paper in the hands of investors, with the goal of increasing its outstandings to $3 billion in the months ahead.   Bank of America and RBC Capital are serving as primary dealers for the securities, which carry P-1/A-1+ ratings from Moody’s and S&P.

Rather than financing clients’ receivables in the conventional sense, Ridgefield is part of a breed of conduits whose proceeds fund repurchase agreements written against the holdings of a counterparty — in this case, corporate bonds owned by BNP Paribas.

In a repurchase agreement, a counterparty sells securities to an investor with a promise to buy them back at a pre-set price. Ridgefield adds a step to that process, using payments on the repo contracts to compensate its noteholders.

But that’s not the vehicle’s most novel feature. Ridgefield is set up to offer what Guggenheim called “serialized commercial paper,” starting with a series called Ridgefield Funding, Series A1, that is backed only by BNP’s repo agreements. The next step would be to add counterparties in the months ahead, with each underpinning a discrete batch of notes.

Because the counterparties won’t be commingled, investors can choose which exposures they want to take on. Another benefit that Guggenheim is pitching to market players: The repo collateral would be bankruptcy remote, and would become accessible to noteholders immediately in the event of a counterparty insolvency. Like many other repo conduits, Ridgefield doesn’t make use of liquidity facilities.

Ridgefield is run by a Guggenheim Treasury team in New York that operates four other conduits with some $20 billion of commercial paper outstanding. Guggenheim Treasury is a unit of the $160 billion Guggenheim Partners of Chicago.

U.S. financial risk council could use more sunlight – GAO” by Sarah N. Lynch, Reuters, September 13:

The new U.S. financial risk council should publicly share more details about its closed-door meetings on emerging risks to markets, a congressional watchdog report has found.

The Government Accountability Office said the Financial Stability Oversight Council, a group made up of the top U.S. regulators, fails to provide insight, even on information that is not market-sensitive.

The GAO’s report raises similar concerns about the Treasury’s Office of Financial Research, another new office created by the 2010 Dodd-Frank Wall Street reform law to analyze data about market threats.

JPM Reviews Prime Money Fund Holdings: Uneventful is Good in August” by Crane Data, September 13:

J.P. Morgan Securities released its latest monthly “Update on prime money fund holdings for August 2012” yesterday, which showed increases in money fund assets, increases in European-affiliated holdings, and increases in average maturities. The latest “U.S. Fixed Income Strategy” research from Alex Roever, Teresa Ho and Chong Sin says, “Prime money market fund assets under management rose by $16 billion (1.1%) in August, a month that was mostly uneventful for the money markets except for the anticipation leading up to the eventually cancelled SEC vote to release money fund reform proposals. …

“Total net bank exposures in prime money market funds increased by $17 billion according to our estimates, driven by increases in unsecured commercial paper/certificates of deposit and repo and offset by decreases in time deposits. Overall asset-backed commercial paper exposures sponsored by banks remained flat month-over-month. In general, funds favored switching out of overnight time deposits (unsecured) to overnight repo (secured) for liquidity …”

Roever, et. al., also write, “Prime money market fund allocations to overnight repo increased to about $200 billion in August, up about $25 billion month over-month and now represents over 70% of total repo holdings in prime money market fund portfolios. Overnight repo holdings remain elevated even as regulatory pressures are forcing broker/dealers to term out their funding liabilities. Basel III’s Liquidity Coverage Ratio in particular would force broker/dealers to hold government securities or cash for expected cash outflows over a 30-day horizon. The bulk of repo funding which is overnight to inside a week would fall under the Liquidity Coverage Ratio, making it costly for broker/dealers to fund shorter than 30 days. We expect such supply pressures on repo over the next several months to lead funds to enter into more term repo trades and seek other sources of overnight liquidity.”

ESRB Aims for EU Shadow Banking Proposals in Early 2013″ by Jim Brunsden and Rebecca Christie, Bloomberg News, September 12:

The European Systemic Risk Board, a group of central bankers and other regulators charged with monitoring market threats, aims to recommend shadow banking oversight changes in early 2013, European Union documents show.

The ESRB wants to mitigate systemic risk associated with shadow banking, according to the papers prepared in advance of a Sept. 14-15 meeting of officials in Cyprus. The panel intends to make policy recommendations on ways regulators can manage the overall health of the financial system and prevent firms from collapsing and triggering contagion.

“Enhanced transparency of certain shadow banking activities is needed to further monitor the sector, for example in the areas of securities lending and repos and other shadow banking entities,” the documents said, referring to repurchase agreements and other financial products.

Collateral, collateral transformation and CCPs: a close look at the crazy numbers” by J. Cooper, Securities Financial Monitor, September 12:

… Collateral transformation trades are a shell game in who holds risky collateral, and the regulators already know it. The risk of the central counterparty clearing house (CCP)-ineligible collateral now shifts to the dealer doing the trade, who then recycles the paper in bilateral or tri-party repo. The UK regulators, in particular, are already cautious about banks loading up on less credit worthy collateral. …

One part of the analysis we have not seen much attention paid to is collateral turnover. High quality paper is re-pledged in the market. Economist Manmohan Singh wrote that collateral velocity is like the velocity of money; clocking in at somewhere between 2 and 2.5. When you dead-end collateral in a CCP, it can no longer be re-pledged. When a collateral squeeze comes, it will be felt in this multiplier.

“Big Banks Hide Risk Transforming Collateral for Traders” by Bradley Keoun, Bloomberg News, September 11:

JPMorgan Chase & Co. and Bank of America Corp. are helping clients find an extra $2.6 trillion to back derivatives trades amid signs that a shortage of quality collateral will erode efforts to safeguard the financial system.

Starting next year, new rules designed to prevent another meltdown will force traders to post U.S. Treasury bonds or other top-rated holdings to guarantee more of their bets. The change takes effect as the $10.8 trillion market for Treasuries is already stretched thin by banks rebuilding balance sheets and investors seeking safety, leaving fewer bonds available to backstop the $648 trillion derivatives market.

The solution: At least seven banks plan to let customers swap lower-rated securities that don’t meet standards in return for a loan of Treasuries or similar holdings that do qualify, a process dubbed “collateral transformation.” That’s raising concerns among investors, bank executives and academics that measures intended to avert risk are hiding it instead.

Securities Finance Monitor reviewed the Bloomberg article in “Bloomberg article on collateral transformation: more questions than answers.

Does Draghi ease collateral shortfall?” by Will Duff Gordon, Data Explorers, September 11:

What does the European Central Bank’s easing of eligible collateral for the Long Term Refinancing Operation mean for the securities finance market? It might mean that there is enough collateral to go round – a huge statement to make regarding the central issue of our times.

“Basel Group Faces ‘Now or Never’ Chance on Bank-Liquidity Rule” by Jim Brunsden, Bloomberg News, September 11:

Global financial regulators begin three days of talks today that may pave the way for a deal on liquidity rules that lenders and the European Central Bank warn could stifle the economic recovery.

The Basel Committee on Banking Supervision will attempt to overcome divisions within its ranks as it races to meet a self- imposed January deadline for reviewing the liquidity coverage ratio, or LCR, three people familiar with the discussions have said. ECB President Mario Draghi has warned the measure risks choking off bank lending, while some other regulators, including in the U.S., say that diluting the LCR risks rendering the standard meaningless, according to the people.

“It’s now or never for the LCR,” Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc., said in an e-mail. “If Basel can’t cobble together an agreement on it that is more than papered-over differences, the U.S. and U.K. will implement their own rules, the EU will stand down and the global liquidity framework may well dissolve.”

The 212 largest global banks would have had a collective shortfall of 1.76 trillion euros ($2.2 trillion) as of June 2011 in the assets needed to meet the LCR, according to figures published by the Basel group based on a draft version of the standard. …

The LCR, which would force banks to hold enough easy- to-sell assets to survive a 30-day credit squeeze, was drawn up by the Basel committee as part of a package of measures in response to the 2008 financial crisis. It is scheduled to become binding as of Jan. 1, 2015.

Are Chinese banks hiding ‘The mother of all debt bombs’?” by Minxin Pei, The Diplomat, September 10:

Financial collapses may have different immediate triggers, but they all originate from the same cause: an explosion of credit. This iron law of financial calamity should make us very worried about the consequences of easy credit in China in recent years. From the beginning of 2009 to the end of June this year, Chinese banks have issued roughly 35 trillion yuan ($5.4 trillion) in new loans, equal to 73 percent of China’s GDP in 2011. About two-thirds of these loans were made in 2009 and 2010, as part of Beijing’s stimulus package. Unlike deficit-financed stimulus packages in the West, China’s colossal stimulus package of 2009 was funded mainly by bank credit (at least 60 percent, to be exact), not government borrowing.

… the potential risk for a financial tsunami is greatest in China’s shadow banking system. Because of very low-yield for savings by Chinese banks (since deposit rates are regulated) and competition among banks for deposits and new fee-generating businesses, a complex, unregulated shadow banking system has emerged and grown significantly in China in the last few years. 

Typically, the shadow banking system pushes something called “wealth management products,” which are short-term financial products yielding a much higher rate than bank deposits for investors….

The shadow banking system has another function: channeling funds to borrowers or activities explicitly banned by government regulation. …

Disturbingly, none of these huge risks are reflected in the financial statements of Chinese banks.

“China re-launches ABS programme for first time since crisis” by Lu Jianxin and Pete Sweeney, Reuters, September 8:

China has re-launched a programme to develop asset-backed securities interrupted by the global financial crisis as the government tries to shore up its banking system.

China Development Bank sold 10.166 billion yuan of credit-backed securities on Friday, marking China’s first sale of such instruments since the global financial crisis caused such products to fall into disrepute.

The asset-backed securities in question are backed by 49 performing corporate loans with a weighted average annual rate of 6.27 percent….

“Regulators choose this time to re-launch the ABS programme primarily to bolster the banking system,” said Liu Junyu, a senior money market analyst at China Merchants Bank in Shenzhen. …

By the expansion, regulators appear to also want to use ABS to help boost corporate fund-raising directly via the market, so as to reduce reliance on bank loans, as well as to give firms an additional channel to raise money through reviving some static assets, they said.

Don’t Make Banks Too Small to Succeed” by Phillip Swagel, Bloomberg News Opinion, September 5:

Calls by former Citigroup Inc. Chief Executive Officer Sanford Weill and others to break up the big banks reflect lingering public fear and anger toward financial institutions that seem too big to fail.

These calls, however, ignore the unintended consequences of making our global banks too small to succeed: Much of the business will migrate to non-U.S. banks and the less-regulated shadow banking sector. …

Shadow banks are almost three times the size of the formal banking sector, and they are less transparent and less regulated, even with heightened attention from the newly created Financial Stability Oversight Council. Lending through shadow banking channels such as securitization or repurchase agreements might not be covered by a taxpayer guarantee, but failures in these parts of the financial system during the crisis brought about government intervention all the same. …

(Phillip Swagel, a professor at the University of Maryland’s School of Public Policy, was assistant secretary for economic policy at the Treasury Department from December 2006 to January 2009.)

“Barclays Abate Says Tri-​Party Repo Grows Strongly, But Will Shrink” by Crane Data, September 5:

A recent “Market Strategy” research piece from Barclays comments on the “Dealer repo activity.” Strategist Joseph Abate writes, “Overall, dealer activity in the repo market has held fairly steady in the past year. But dealer activity in the bilateral market is declining. … Dealers are active participants in the tri-party and bilateral repo markets. They use the tri-party market mainly to finance themselves and the bilateral repo market for trading specific collateral. Cash borrowings in the bilateral repo market have been falling since last summer. Bilateral repo now accounts for less than 35% of all dealer repo outstanding. Meanwhile, dealer tri-​party repo volumes are increasing. We estimate that money funds provide about 40% of the $1.5 trillion in tri-party repo. …

He continues, “We believe that pending regulatory changes will likely shrink the size of the tri-party repo market. However, while some of these financing trades might migrate to the bilateral market, we suspect that dealers are more likely to shrink as their ability to maintain a $600 billion repo market funding gap declines.” …

“A smaller tri-party market — particularly given the increase in its participation in the past year — may create some congestion for money funds looking for safe investments among sparse government supply. But, there could be some relief if bilateral repo (currently at $1 trillion in outstandings) picks up the slack. However, this requires that some traditional tri-party lenders such as money funds sacrifice some of the efficiency from the tri-party market for access to more collateral in the bilateral market.”

“Bank regulators warm to liquidity rethink” by Brooke Masters, Financial Times, September 2:

Global regulators are coalescing around plans to soften the impact of planned bank liquidity buffers by allowing institutions to count a wider variety of assets towards the requirements and changing the calculations in key ways to somewhat reduce the overall amount.

The Basel Committee on Banking Supervision, which sets the worldwide standards, has been promising for more than a year to take a second look at the “liquidity coverage ratio”, which is due to take effect in 2015 and requires banks to hold a stock of easy-to-sell assets against a 30-day market crisis.

The liquidity coverage ratio is a groundbreaking attempt to prevent runs like the one that brought down Lehman Brothers in 2008. But industry groups say the current version, which limits the buffer to cash, sovereigns and top quality corporate bonds, will hamper lending and some central bankers fear it will hinder efforts to stimulate the economy.

A Basel working group recently narrowed possible revisions to half a dozen serious proposals that will be considered at a meeting next week. Not all will pass and negotiations are expected to continue into the next meeting in December….

People familiar with the discussions say the industry has had little success persuading anyone beyond the European Central Bank to accept asset-backed securities, despite extensive lobbying.

Russian Banks More Than Doubled Repo Borrowing In Second Quarter” by Artyom Danielyan and Stepan Kravchenko, Bloomberg News, August 31:

Russian lenders more than doubled the average amount borrowed via repurchase agreements with the central bank to 908.6 billion rubles ($28.1 billion) in the second quarter from 382.8 billion rubles in the previous three months, according to a report published on Bank Rossii’s website today.

Search for yield boosts esoteric ABS” by Tracy Alloway, Financial Times, August 30:

Yields from US Treasuries and top-rated corporate bonds may be trading near record lows, but investors still want returns. Bankers have been willing to oblige. By slicing and dicing a host of unusual assets from racehorse semen to timeshare loans, they have been stepping up their marketing of income-producing investments to sell to investors.

So-called esoteric asset-backed securities have been in the market for years. But in recent months demand for yield has helped push this market towards recovery. While issuance has dropped from pre-crisis levels of as much as $45bn, esoteric deals are one of the few ABS markets where sales are increasing.

They are typically backed by cash flows from assets such as timeshare loans and shipping container leases but can stretch to more exotic items such as music and film rights and even pizza franchises and pharmaceutical patents. That differs from the home equity, credit card and auto loans that secure more familiar and traditional ABS.

U.S. Money Fund Exposure and European Banks: Shift to Japan Continues” by Martin Hansen, Kevin D’Albert, and Robert Grossman, Fitch Ratings, August 29:

… While money market fund allocations to European banks increased moderately since end-June, the proportion of secured exposure in the form of repurchase agreements (repos) also continued to climb (see chart, Repos Continue to Rise). As of end-July, repos represent about 36% of money market fund allocations to European banks. It is important to note that the quality of repo collateral can vary, as illustrated in Fitch’s report, “Repos: A Deep Dive in the Collateral Pool” (August 2012).

Foreclosure-rental bonds come to market without ratings” by Adam Tempkin and Charles Williams, Reuters, August 24:

The first so-called real estate owned (REO)-to-rental securitizations in the United States may go ahead without credit ratings, as agencies ponder how to assign grades to the new and potentially risky products.

In the planned deals, real estate and private equity investors would buy up blocks of foreclosed properties and rent them out to borrowers who have been displaced due to their unpaid mortgages. The rental payment streams – and possibly the proceeds from an eventual sale of the properties – would provide payments to bond investors.

Costs rise for legacy ABS” by Anil Mayre, Reuters, August 24:

The weaker financial position of banks providing various roles in securitisation structures within the current regulatory framework has had a monetary impact on terms for issuers, which are not just counting the number of notches of downgrades.

Liquidity facilities designed to be a support mechanism and cover shortfalls were employed in a number of pre-crisis deals. And while they only accounted for a small percentage of portfolio sizes (typically single digits) and pay down over time, their costs continue to rise for both providers and recipients. The problem is a painful combination of capital charges and downgrades.

“Structured Repos Signal Market Appetite, Liquidity Risks” by Fitch Ratings, August 23:

Investor appetite for legacy, distressed structured finance securities continues to drive their acceptability as repo collateral. Fitch’s analysis of repo collateral trends, which covers the most recent Form N-MFP reporting period of end-May 2012, reveals that lower quality securities still predominate the collateral pools backing structured finance repos, with Countrywide, Bear Stearns, Lehman, and Washington Mutual ranking among the ten largest issuers of structured finance repo collateral. In terms of overall volumes, Federal Reserve Bank of New York (FRBNY) data indicates that roughly $75 billion of structured finance securities were financed through tri-party repos as of July 2012. Funding these less liquid, more volatile securities through short-term, wholesale borrowing poses potential liquidity risks to both repo market participants and the broader structured finance market….

For both investors and financial institutions, the persistent low-yield environment has likely played a pivotal role in stimulating appetite for these riskier securities. … However, funding these less liquid, low-quality securities through repo markets poses broader risks within the financial system.

ABS Sales Fall In Europe On Central Bank Funding, S&P Says” by Tom Freke, Bloomberg News, August 22:

Sales of asset-backed bonds are falling in Europe as issuers take advantage of cheap central bank funding, according to Standard & Poor’s. …

Banks sold 44 billion euros ($55 billion) of bonds backed by mortgages, auto loans and credit-card payments in the first seven months of the year, about 10 percent lower than for the same period of 2011, S&P said, citing data from JPMorgan Chase & Co. Almost 50 percent of the notes sold were backed by prime U.K. home loans.

Volumes of ABS plunged about 80 percent in the five years since the financial crisis started, after previously fueling economic growth by allowing lenders to refinance the cheap credit they extended.

J.P. Morgan sees first HKD triparty repo transaction” by Securities Lending Times, August 22:

J.P. Morgan Worldwide Securities Services has executed Hong Kong’s first HKD triparty repo transaction between Bank of China and Barclays.

The bank and the Hong Kong Monetary Authority collaborated on a repo financing collateral management programme to facilitate repo financing transactions between members of Hong Kong’s Central Moneymarkets Unit (CMU) and international financial institutions. The programme launched in June….

The trade “leveraged the cross-currency, cross-border and global capabilities of the repo financing programme and J.P. Morgan platforms by mobilising US Treasuries against HKD liquidity,” said J.P. Morgan in a statement.

Kirit Bhatia, head of technical sales for Asia (excluding Japan) at J.P. Morgan Worldwide Securities Services, said: “This is an exciting milestone for Hong Kong as it points to the new opportunities for local and global firms seeking to participate more deeply in the region’s rapidly developing capital markets. We look forward to playing a key role in the market’s ongoing development.”

Are Giant Banks Indispensable? No, Says Big Business” by Maria Aspan, American Banker, August 21:

Big banks love their biggest customers, but the feeling isn’t always mutual.

That has become evident as the nation’s largest banks try to fend off a fresh wave of criticism that their size and marriage of investment and commercial banking pose a grave risk to the financial system….

JPMorgan Chase (JPM) Chief Executive Jamie Dimon has argued that big corporate customers rely heavily on the sophisticated financial services only megabanks can provide, including big loans, global cash management and deal advice….

Nobody interviewed for this article advocated breaking up big banks, but corporate officials carefully expressed frustrations with the side effects of the megabanks’ heft. The growing concentration of banking industry assets since the financial crisis has made dealing with the largest banks inevitable for many companies — and often requires buying a bundle of services to get the best deals on credit.

Years of Scandal” by Christopher Matthews, Time, August 15:

America has been afflicted with one financial scandal after another over the past generation – culminating in the 2008 financial panic, the effects of which we are still suffering under. It has widely been assumed that each of these scandals have had disparate causes, but in their new paper (William) Bratton and (Adam) Levitin argue that three of the most notorious scandals of the past generation — Michael Milken’s junk-bond-related securities fraud in the 1980s, the Enron scandal of the early 2000s, and the subprime mortgage meltdown of 2007-08 — are all linked by their use of an esoteric accounting mechanism called a “special purpose entity,” or SPE.

“‘The new form of corporate alter ego’: SPEs, encore” by Joseph Cotterill, Financial Times Alphaville, August 14:

We qualify ‘new’. This paper is a full 30-year history of the special-purpose entity in banking, from Mike Milken to the Abacus CDO, via Bistro — up to the denouement of FAS 167.

Penned by William Bratton and Credit Slips blogger Adam Levitin, it also points out that corporate law continues to lag the accountancy profession in understanding the implications of SPEs. That weakness is important when the original purpose of many SPEs — for banks to replace equity with contracts as a means of controlling assets taken off-balance sheet, in order to gain relief from regulatory capital — is as relevant as ever.

DTCC’s Avox Launches Legal Entity ID Portal” by Tom Steinert-Threlkeld, Securities Technology Monitor, August 9:

Avox has launched a Web portal that gives access to legal names, parent company names and other background data on 459,000 participants in financial market transactions.

When and where available, the data will include the Interim Compliant Identifiers mandated by the Commodities Futures Trading Commission.

European unsecured bank debt issues fall” by Mary Watkins, Financial Times, August 8:

The proportion of senior unsecured debt issued by banks in Europe this year has fallen below 50 per cent of new issuance for the first time in five years, underlining how problems in the eurozone and new regulations are driving banks to tie up more of their assets to access funding.

All eyes on asset encumbrance in Europe” by Izabella Kaminska, Financial Times, August 8:

Fitch has published an in depth analysis of encumbrance on EU bank balance sheets on Wednesday — a key talking point given the market’s current focus on such senior debt, such as covered bonds, repos and central bank funding.

The results are interesting because, by and large, they show there aren’t any real trends at all. …

Nevertheless, it’s still the case that the global trading banks that appear to “suffer” from over exposure, do so due to their repo operations. Levels vary from bank-to-bank depending on the weight of trading business relative to commercial banking and the extent of re-hypothecation (the practice of reusing assets).

Corporate Cash Chasing Low-Risk Yield” by James Willhite, CFO Journal, August 7:

Corporate cash investments in asset-backed securities continued their upward march in July, settling at their highest level in four years as a component of cash balances.

“Banks’ Liquidity Hinges on Risky Assets” by Vincent Ryan,, August 6:

By funding short-term cash needs with structured-finance securities, banks are creating significant liquidity risks for themselves and some of their markets, says Fitch Ratings.

Repos, or repurchase agreements, are a key source of short-term financing for Wall Street banks and other financial institutions, and they are under scrutiny once again for being fraught with risk.

A Fitch Ratings report last week found a significant weak point in repo markets, a part of the “shadow banking” system that finances trillions of dollars in banks’ trading activities.

The repo market is “an important utility in the financial system and promotes liquidity,” says Martin Hansen, senior director of macro credit research at Fitch Ratings. The problem with the repo market currently, though, is the quality of the collateral Wall Street banks and other financial institutions are using to borrow this short-term cash, says Fitch.

The danger of repo” by Felix Salmon, Reuters, August 6:

Remember how there’s a very good chance that Treasury’s new floating-rate notes are going to be linked to some kind of repo benchmark? Well, here’s another reason that’s a bad idea: the repo market is shrinking fast, at least in Europe — and if it can shrink in Europe, it can do so in the US, as well.

What’s more, we want the repo market to shrink. … Repos … epitomize the paradoxical and ultimately destructive desire on the part of people with money to lend out money but to take no credit risk while doing so. …

And in times of crisis, a reliance on repo markets makes all banks incredibly fragile, and vastly increases the risk to taxpayers should a bank fail.

Key repo contracts market falls 14%” by Mary Watkins, Financial Times, August 5:

The market for a key funding instrument for banks has shrunk in Europe, highlighting how reliant financial insitutions in the region have become on European Central Bank support.

The market for European repurchase, or repo, transactions contracted by an estimated 14.2 per cent year-on-year in the six months to June 30, based on constant samples over the period.

The total value of outstanding repo contracts – in which banks pledge their securities as collateral for short-term loans from money market funds or other investors – stood at €5.647tn in June, according to the latest bi-annual snapshot of the market by the European Repo Council of the International Capital Market Assocation (ICMA).

“EFSF repo request bolsters peripheral rally” by John Geddie, International Finance Review, August 4:

The European Financial Stability Facility’s request for bank loan facilities, and specifically a repurchase facility, bolstered buying in peripheral Europe on Friday.

Bank sources said they had received a request on Friday morning for a repo facility from the EFSF, following earlier requests for uncommitted unsecured and committed secured loans over recent weeks.

“The repo facility is a signal that the EFSF wants to be fully ready for any proposed secondary market intervention,” said Sphia Salim, European rates strategist at Bank of America Merrill Lynch.

Congress Considers Health of Tri-Party Repo Market” by C-Span, August 2:

Senators Jack Reed & Mike Crapo say it’s crucial to clarify which government regulatory agency has sole oversight authority of the tri-party repo market. The Chairman and Ranking Member of the Senate Banking Subcommittee on Securities, Insurance & Investment convened a hearing Thursday on the potential risks repos pose to the broader U.S. financial system.

In testimony, Matthew Eichner, the Federal Reserve’s Research and Statistics Division Deputy Director listed a few agencies but couldn’t name the lead oversight agency which concerned lawmakers. Eichner stressed that while the market has improved its risk management since the 2008 financial crisis, he believes vulnerabilities remain and need to be addressed. Representatives from two clearing banks, BNY Mellon and Morgan Stanley, and an investors’ group also testified.

(RepoWatch editor’s note: See the related August 3 Wall Street Journal story “Fed sees risk in a big repo market” by reporter Andrew Ackerman who calls the tri-party repo market “an obscure but enormous corner of the financial system.” RepoWatch believes U.S. business reporters and editors need to ask themselves why they allow an “enormous corner” of the financial system to be “obscure.”)


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