posted on 02 May 2016
from Liberty Street Economics
-- this post authored by Jacob Adenbaum, David Hubbs, Antoine Martin, and Ira Selig
In a recent Important Notice, the Fixed Income Clearing Corporation (FICC) announced that it would no longer support interbank trading for its General Collateral Finance Repo Service. (GCF Repo®, hereafter GCF Repo, is a registered service mark of FICC.) But what exactly is the GCF Repo market? And what is interbank GCF Repo specifically?
In a series of four posts we take a close look at the GCF Repo market and how it has evolved recently. This first post provides an overview of the GCF Repo market and evaluates its size relative to that of the tri-party repo market as a whole. We also explain what interbank GCF Repo is and show what share of the market it represents.
Intrabank and Interbank GCF Repo
FICC's GCF Repo service allows its members to trade repo contracts anonymously through interdealer brokers, with FICC serving as the central counterparty. As described in this Primer, GCF Repo is one way for dealers to obtain collateral and secure funding. Dealers submit GCF Repo trades anonymously, through interdealer brokers, and FICC guarantees, nets, and novates GCF Repo trades. (Through novation, FICC becomes the buyer to every seller and the seller to every buyer.)
GCF Repo trades settle on the clearing banks' tri-party repo settlement platforms, along with other tri-party repo trades. The two tri-party repo clearing banks in the United States are JPMorgan Chase and Bank of New York Mellon. Typically, each dealer uses only one of the two clearing banks for its settlement needs. The "intrabank GCF Repo" trades that use the same clearing bank can settle without the need for the clearing banks to communicate. In contrast, "interbank GCF Repo" involves both clearing banks and requires some communication between the two. This difference is important because intrabank trades mostly conform to the road map for repo settlement set forth by the Tri-party Repo Infrastructure Reform Task Force, but interbank trades don't. Indeed, settling an interbank GCF Repo currently requires the clearing banks to extend large amounts of credit.
How Big Is the GCF Repo Market?
Since GCF Repo settles on the clearing banks' tri-party platforms, it is often viewed as part of the overall tri-party repo market. The chart below shows that both the tri-party and GCF Repo markets, as measured by settlement volume, have decreased in recent years. In a previous post, our colleagues studied whether recent regulatory changes may have contributed to this decline by prompting dealers to revise their repo strategies.
There are several ways to measure GCF Repo market size. One method is to look at the sum of the value of all trades in the market; this provides a gross measure of activity. Another method is to calculate settlement value in the GCF Repo market - a measure that is distinct from the sum of total repos because FICC nets offsetting repos and reverse repos within a collateral class when GCF Repo trades settle. (While the two measures differ in GCF Repo, they are the same in the tri-party repo market exclusive of GCF Repo because dealers cannot net their offsetting positions.) We can calculate the settlement value as the sum of all the dealers' positive net positions within each collateral class - that is, the total value of the collateral in the market. Since 2012, settlement in the GCF Repo market has shrunk from more than $250 billion to approximately $175 billion on an absolute basis, and has decreased somewhat as a proportion of the overall tri-party repo market.
How Big Is the GCF Interbank Segment?
The GCF Repo market can be further broken out into interbank and intrabank components by summing the net settlement positions of all the dealers for each clearing bank. Because some trades can net during settlement, this measure of interbank activity can miss some trades that actually occurred between dealers. What it captures is the total amount of collateral in the market that relies on interbank GCF Repo to settle. We think this is a useful measure. To understand why, suppose a dealer looking to lend against Treasury securities can choose between two similar trades, one from a dealer at the same clearing bank and another from a dealer at the other clearing bank, between which it would be broadly indifferent. Because the trades in GCF Repo are blind-brokered, the trade the dealer will ultimately choose could be either random or determined by the actions of the interbroker dealer. The dealer would thus have a roughly 50 percent chance of doing an interbank repo, even though a similar trade could have occurred on an intrabank basis. By considering interbank settlement, we capture the value of the collateral that could not be settled on an intrabank basis.
The next chart shows that the share of interbank GCF Repo decreased from more than 20 percent in parts of 2012 to between 10 and 15 percent today. In 2015, interbank GCF Repo represented an average of 1 percent of the overall tri-party market.
Not the First Time
FICC suspended interbank activity once before, between 2003 and 2008, so its upcoming suspension is not unprecedented. The objective of that suspension was also related to the extension of intraday credit, but the issue was somewhat different, as we explain below.
The Government Securities Clearing Corporation, FICC's predecessor, developed the GCF Repo product with the two clearing banks in 1998, and service began on an intrabank basis only. Interbank trading began in 1999 and increased rapidly following its launch. At the time, settlement of the tri-party repo market, including GCF Repo, involved a morning "unwind" (see the Economic Policy Review article "Key Mechanics of the U.S. Tri-Party Repo Market"), in which collateral was returned to the borrowers and cash was returned to the lenders. With interbank GCF Repo, this unwind entailed large extensions of intraday credit between clearing banks. To eliminate that risk, FICC suspended interbank GCF Repo on March 11, 2003, and did not reinstate it until several years later in 2008 after it had developed a solution to the problem with the clearing banks.
Déjà Vu All Over?
It may be tempting to look to the 2003-08 suspension of interbank GCF Repo as an indicator of what might happen when interbank GCF Repo is suspended again later this year, but the repo market has changed so much since 2008 that lessons from that period may not provide much insight. The changes include the tri-party repo infrastructure reform (which has led to the practical elimination of the morning unwind) and a shift in the market share of the two clearing banks, as well as the regulatory changes coming from Basel III.
In the next three posts, we provide some useful ways of looking at the GCF Repo market and its recent evolution. Tomorrow's post describes the amount of activity by each clearing bank and the various collateral classes traded in this market.
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
About the Authors
Jacob Adenbaum is a senior research analyst in the Federal Reserve Bank of New York's Research and Statistics Group.
David Hubbs is a payment clearance and settlement associate in the Bank's Integrated Policy Analysis Group.
Antoine Martin is a senior vice president in the Bank's Research and Statistics Group.
Ira Selig is a payment clearance and settlement manager in the Bank's Financial Institutions Supervisory Group.
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